Hot Air

It was all going so well. Cigars and brandy around the hearth. Silk and cashmere. Fine Corinthian leather. The big industrial gas companies were having a jolly good time at the Oligopoly Club. Air Liquide, Linde, Taiyo Nippon Sanso and Air Products shared some laughs and enjoyed a few games of whist.

But across the street, a new eco-friendly club was opening. It was 2022, and the party was just starting. The DJ was laying down some insane beats. Air Products dreamily gazed through leaded glass at the crowd lining up behind the velvet ropes. It’s now or never…

Pulse quickening, cash in hand, Air Products suddenly stood below the green backlit sign. Club H2. One bouncer whispered to the other. Are they pointing at me? I’m in. This is happening.

Once inside, Air Products wasn’t so sure they made a good decision. Bottle service? Really? This seemed frivolous, but the hostess insisted. Three magnums of Cristal later, the room began to spin. Air Products saw an exit sign through the haze, but big guys in black t-shirts blocked the door. The next morning was, wait – it is the next morning.  

I’m going to tell you about the misadventures of Air Products since 2022. The staid Allentown, Pennsylvania, company chased the illusive promises of a green future all the way to Saudi Arabia. Once the true costs and debt obligations became clear, shareholders revolted in early 2025. If you stick with me, I will also present two valuations for Air Products. Both methods indicate that the market price of the company’s shares is well above the intrinsic value of the business.

Industrial gases play a significant, if invisible, role in economic productivity. Hydrogen, oxygen, and their molecular cousins are essential for petroleum refining, fertilizer production, and the manufacture of metals and silicon wafers. Healthcare couldn’t function without oxygen and nitrogen. With such essential uses, industrial gas businesses can be very profitable.

For many years, the world’s leading producer of industrial hydrogen was stable, boring, but steadily improving. Air Products was a stock you could recommend to your grandmother. APD generated over $12 billion in sales in fiscal year 2024. With a market capitalization of over $63 billion, Air Products grew earnings 7.5% per annum for a decade and dividends followed suit. Leverage was moderate. Capital investments flowed steadily from retained earnings. The company was responsible. It lived within its means. Returns on equity consistently posted in the mid-teens. Net margins hovered around 20%.

In 2022, Air Products was lured by the siren song of environmentally sustainable hydrogen production. Through a series of joint ventures, the company made substantial capital commitments. APD made an $8 billion promise to a blue hydrogen facility in Louisiana and a stunning $9 billion dollar commitment to a green hydrogen joint venture in Saudi Arabia. Three smaller sustainable hydrogen projects in the US accounted for a further $3.1 billion. Along the way, they divested their liquified natural gas business for $2 billion.

Air Products began to borrow. Big time. Long-term debt had hovered around $3 billion dollars for several years before surging to $7 billion after the pandemic, and then to over $13 billion today. Prior to 2022, capital expenditures were marching in line with depreciation at around $1 billion per annum. Recently, they have ballooned to over $4 billion per year. Free cash flow turned negative, and the dividend now seems precarious.

Most hydrogen is produced using a process known as steam methane reforming. High pressure steam separates hydrogen from methane (CH4), with carbon monoxide and carbon dioxide as the byproducts. Natural gas is usually the source of methane in this process. The less common production method is electrolysis which involves splitting water molecules using electricity. It’s uncommon because it’s very expensive.

Green hydrogen production means that the power for electrolysis is provided by renewable sources – mostly solar and wind power.  Blue hydrogen is the moniker given to production using natural gas where the carbon byproducts are recaptured and stored. Both means of production are environmentally friendly, but they are dependent upon government subsidies to make the numbers work. The rug-pull for American production came from the Trump administration earlier this summer. Funding for major green and blue hydrogen production was dramatically curtailed.

Like the roommate holding your hair back while you heave into the toilet, shareholders recognized that the Cristal was a seriously bad idea. A proxy battle led by Mantle Ridge Capital resulted in the replacement of three directors and the installation of a new CEO early in 2025. Eduardo Menezes, who replaced the octogenarian Seifi Ghasemi at the helm, wasted no time shutting down three green and blue hydrogen joint ventures in California, New York and Texas which resulted in a $3.1 billion write-off.

Ironically, nine years ago, Ghasemi had been installed by Mantle Ridge. By 2025, the worm had turned. Mantle Ridge is led by Paul Hilal, an activist investor who may be more famous for his tenure at Pershing Square with Bill Ackman. I first learned about Hilal while reading the highly entertaining autobiography of Hunter Harrison, Railroader. Harrison was a force of nature, and he revolutionized the railroad industry.

Pershing Square’s 2012 activist campaign for Canadian Pacific was arguably one of the finest investments in modern market history. While Ackman grabbed the headlines, it was Hilal who worked the numbers and recruited Harrison – already an industry legend – to western Canada. People said you could never get CP’s operating ratio below 60% because of the mountainous terrain. Harrison did it, and more. 

So, when I see Hilal’s involvement with a company it comes with serious gravitas. The man knows how to generate shareholder value. The question now becomes, has Air Products mired itself so deeply in unfeasible green and blue hydrogen projects that its future profitability is in doubt?

I think the answer is yes. Menezes and Hilal have a long road ahead of them. While the Louisiana project may turn out to be a winner, the Saudi Arabian green hydrogen investment seems destined for trouble. Air Products has a 30-year offtake agreement for the ammonia expected to be produced by the project. While they have obtained a take-or-pay commitment from TotalEnergies for a third of future production, the lack of foreseeable sales is a dark cloud on the horizon.

The Saudi project is known as NEOM Green Hydrogen (NGHC), and it is breathtaking in its ambition and lack of market potential. A joint venture between Air Products and Saudi power companies, the massive site on the Red Sea will have 4 gigawatts of solar and wind power. By 2027, the venture is expected to produce 1.2 million metric tons of green ammonia per year. The ammonia is useful for fertilizer production, but it also aims to become a source of clean fuel.

Scientists have yearned for a hydrogen power solution for decades. A hypothetical pipeline route was drawn for Europe during the 1970’s. Many scientists regard hydrogen as the holy grail of clean energy (all that water!), yet production is economically unfeasible without massive government subsidies. Transport and storage is highly complicated and unproven.

Nobody delivers the sobering truth about the lack of viability for green hydrogen better than Michael Liebrich. His keynote address at the Hydroverse Convention earlier this year…Ouch… Well, let’s just say the audience wasn’t enthusiastic. 

NGHC is one of the industrial centerpieces of the futuristic master-planned development known as Neom. The vision, led by the Saudi crown prince, is to build a modern city of over a million people with a cost of over $1 trillion. It is designed to showcase the kingdom’s transformation away from fossil fuels and act as a technological innovation hub for the region. Already well over budget, the project has been scaled back. Yet NGHC moves forward, and construction is nearly 80% complete.

Air Products will tell you that you shouldn’t worry about NGHC because the financing in non-recourse. If that helps investors sleep at night, remember that this is a country that once held several errant business leaders captive at the Riyadh Ritz-Carlton for several weeks. Is there really such a thing as non-recourse when it comes to Saudi Arabia? You get a strange feeling when you watch Cristiano Ronaldo talk about playing soccer in his adopted land. Like maybe his soul has left his body. I had the same sinking feeling watching the Saudi national anthem played before the Bud Crawford fight.

Air Products is all-in on Louisiana and all-in on Neom. Economics be damned.

Air Products’ share price rallied after the boardroom coup d’etat. Investors seem placated by the choice of Menezes and they hope the steady returns of the past can be replicated once the new projects come online. After all, a 15% return on the $17 billion of green and blue hydrogen investments would effectively double current levels of net income which amounted to roughly $2.8 billion over the trailing twelve-month period.

Failure to deliver, however, and the company faces years of painful asset write-downs and a debt hangover. With few customers for Saudi green hydrogen on the horizon, the latter prospect seems more likely.

I present two valuation models below. The first is an earnings power valuation. The simple approach is advocated by Bruce Greenwald, heir to the Columbia value investment lineage that descends from Ben Graham. The model for EPV is simple. Take normalized free cash flow, or “owner’s earnings” in Buffett’s parlance, and divide by the weighted average cost of the firm’s capital.

The major limitation with the Greenwald method is its inability to account for growth. It takes the past results and capitalizes them, making no calculations for the future.

Value investors are a lonely bunch. The market has moved on. In a world trading on vibes and memes, the value investor is as quaint and archaic as the old boys’ club in the first paragraph. One could take a shot at projecting cash flows into the future and discounting them to the present. But the future is so uncertain. So someone from the value investment world needed to step up and properly account for a company’s future growth.

Into the breach stepped Stephen Penman and Peter Pope, again of the Columbian tradition. Their book Financial Statement Analysis for Value Investing (Columbia U. Press, 2025), is an excellent addition to the canon. They are accountants, and they contend that growth is only valuable to the extent that future earnings exceed a hurdle rate of return. If a company’s net earnings represent a 12% return on the company’s book equity, and the hurdle for such a company is 10%, then one can figure that this additional 2% is where real value is created.

They take the book value of the company’s equity and add a capitalized value for these residual or surplus earnings. Growth is factored in the denominator. The higher the growth, the lower the denominator, the higher the residual value.

A value investor can solve for the growth rate to see if a price makes sense. They offer a compelling example of Buffett’s purchase of Apple. At the time, in 2016, solving for the “g” in the growth portion of the equation showed that Apple’s price anticipated only a 2% growth rate. It was certainly a safe wager to think that Apple could manage better than 2% growth.

The problem with the model is that the authors don’t have much of an answer for the hurdle rates they choose. Yes, they spend several pages talking about risk and leverage, but ultimately they settle on the investor’s preference. The reader craves Damoradan’s rigorous precision. Penman and Pope (and Munger and Buffett) scoff at complicated equations. Precision can be precisely wrong. They would probably contend that its better to have that margin of safety in a 12% hurdle rate for a risky venture, than calculate some kind of Frankenstein-WACC with beta at its core.

The earnings power valuation (EPV), a zero-growth model, indicates that APD may be worth less than $100 per share. This would mark a 66% decline from current levels. In this model, unlevered free cash flow is divided by a weighted average cost of capital of 8.13% to arrive at a value of $23.5 billion after subtracting $14.6 billion for the market value of net debt.

The “accounting for value model” or “Penman-Pope Model” is a lot more forgiving because it makes an accommodation for growth. We start with the base. Penman and Pope frequently ask the reader to “take the balance sheet with you.” Here we use the book value of equity, $15.5 billion, as the first half of the equation.

The second half of the equation is determining residual earnings for the following year. In this case, I simply increased trailing twelve-month earnings by 4%. This may be slightly hopeful, but its not unreasonable. Note: unlike the unlevered cashflows of the EPV model, earnings are net of debt expenditures. The “hurdle” I set for Air Products was 9.28%. This is the 10-year treasury yield, plus a spread for the company’s A-rated debt, and an additional 4.33% equity risk premium.

Air Products delivered a 16% return on equity for the TTM 2025 period, so the residual earnings – the amount above the hurdle – is $1.4 billion. The figure is divided by a denominator of r – g where r is the 9.28% cost of equity less a proxy for growth. In this case I used 4.27% (the 10-year Treasury yield). The residual value is approximately $25.4 billion. Added to book value, the sum is $40.9 billion or about $185 per share. This represents a level 35% below the market price.

The aspect of the model that is appealing, is that it allows one to see whether growth is reasonable. In other words, what level of growth would justify today’s price of $283 per share? The answer is 6.6%. If you think world demand for hydrogen meets or exceeds this level, you would conclude that Air Products is fairly valued.

So, these are just my estimates and they are certainly crude. I don’t make any attempts to understand the potential demand for green hydrogen in Europe or the possibility that production costs could be dramatically reduced through lower energy inputs from solar power. I certainly would think twice before betting against Paul Hilal.

However, despite our best intentions to improve the environment, the efforts at carbon recapture and electric hydrolysis have relied heavily on government subsidies. As governments reckon with yawning fiscal gaps and a need to re-arm for global conflicts, it seems likely that the green ammonia produced in Saudi Arabia lacks an end-market. The uncomfortable meetings in the Air Products boardroom could persist for many years as assets are written-down and debt service gnaws away the bottom line.

Until next time.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by

Healthpeak

I don’t have much time this week, so I’m in shallow water. I’ve got a little back-of-the envelope one for you. Healthpeak Properties Trust (DOC) is a Denver-based owner of outpatient medical buildings and lab space. The company merged with Physicians Realty Trust in 2024. The stock has not performed well, but the 7% dividend yield is very enticing. DOC trades with a market cap of $12.5 billion.

The dividend seems well-covered, however the lab space (31% of revenues) is a wildcard. There has been an incredible amount of new supply, and the biotech market isn’t exactly robust. Despite the risks, this one deserves a closer look.

For now, here are my rough numbers. I am taking a leap of faith by annualizing just one quarter for the balance of 2025. The stock trades with an FFO yield of approximately 11%. I subtracted maintenance capital expenditures (taking management at face value) from net operating income, and it appears that the real estate trades for an implied cap rate of 7.3%. This seems pretty high, but it probably reflects the risks associated with lab space tenants. Leverage is also a little higher than I’d prefer, but the maturity timetable appears manageable.

The problem with Healthpeak, and so many other office REITs for that matter, is “what does upside look like?” How does this story improve? It’s not like the National Intitutes of Health is going to start writing grant checks for new clinical trials any time soon. Healthpeak doesn’t have the ability to refinance debt any more cheaply than what’s on its books today.

Beware the siren song of high dividend yields. Usually the market knows something about risk that you don’t. If you’re just buying debt with a single-B credit rating, you should definitely receive more than 7% on your money. The “equity” may not be worth more than a similar junk bond.

Until next time.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by

The Road to Wellville

I keep a $5,000 short position in Welltower. It’s my hairshirt. I know it won’t change anything. My penance will not help mankind. I continue to view Welltower (WELL) as the most absurdly overvalued real estate investment trust in the market today. The company is a provider of senior living residential facilities. Welltower mesmerizes all who worhsip at the orthodox church of demographics. “Thou shalt not question thy trend of aging baby boomers” is the first commandment obeyed by all who kneel at the altar. Yet here I am. Tilting at windmills.

Welltower hovers near the $100 billion market capitalization level. No REIT can match Welltower for its voracious pace of expansion which exceeds double digit percentages on an annual basis. It has been an incredible growth story. But growth requires capital, and capital comes from the addition of new shares and debt. REITs, by their tax-advantaged status, must distribute most of their net income to shareholders. Retained earnings are usually a small source of investment capital.

Issuing new shares and debt for growth works just fine for as long as you can earn a return above the cost of capital. More shareholders aren’t a problem as long as the pie is bigger. Fail to do so, and the music eventually stops. REITs become dilution machines. Welltower is on the cusp of such an inflection. The company has raised nearly $21.5 billion in new shares since Covid. It has worked so far, but Welltower now struggles to cover its shareholder distributions. Will the market eventually figure it out?

Welltower’s real estate is valued by the market at an eye-watering implied capitalization rate of just over 2.5%. The FFO yield is 2.5%, and dividends yield a paltry 1.76%. In fairness, housing the elderly is more than just real estate. Services are a key part of the menu. But here’s where it gets worrisome: Welltower is unable to cover it’s current dividends with operating cash flow. By my estimation, about 25% of the company’s dividends to shareholders are funded through the issuance of new shares. The music is playing. The chairs are in a circle.

Just for fun, let’s look at BXP. One of the leading office landlords, BXP has seen its challenges since Covid. The stock trades with a $12.8 billion market cap and offers a 5.44% dividend yield. The implied cap rate for some of the nation’s premier office buildings is about 6.22%. This seems like a reasonable cap rate, until you start asking this question: “Who are the next buyers of these office buildings?” Pension funds probably aren’t lining up to acquire these assets. No more trophies. Class A in appearance, Class A in rentability, but probably not Class A in the transaction market.

Lest you be tempted by the 5% dividend yield, you should know that BXP also struggles to pay that dividend with cash flow.

So, it’s a quick look at a couple of REITs this week. It’s Father’s Day, so brevity is best.

Until next time.

Note: The estimate of maintenance capital expenditures for Welltower is based on 1.41% of depreciated assets in service. This is the average level of improvements as a percentage of total assets for the past six years. Also, some of you may think that I am unfairly punishing these two REITs by deducting capital expendiures from net operating income. I will say that my experience has been that you can’t have it both ways. You can’t add back depreciation AND exclude capital expenditures.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by

Hold the mayo.

Kewpie Mayonnaise is a household staple in Japan. It was introduced to the country in 1924 after Toichiro Nakashima enjoyed the condiment during a visit to the United States. Today, Kewpie has been elevated to cult status. You can even visit the company “terrace” in Tokyo. Many Western chefs say it’s the best mayonnaise in the world. Kewpie is serious about its appeal beyond Japan and just opened a new production facility in Tennessee.

Japanese mayo uses only egg yolks, so it has a more yellowish appearance than, say, Hellman’s. Creamier and mellower than it’s US cousin, Japanese mayo receives a distinct character from the addition of apple cider vinegar and monosodium glutamate (MSG). The American version of Kewpie omits MSG. Purists say don’t bother. Go straight to the Japansese original for the best flavor. MSG gets a bad rap in the States, but aficionados rave that the addition of monosodium glutamate triggers the famous “fifth taste” known as umami.

Kewpie (2809.T) has a market cap of ¥481.8 billion ($3.34 billion). The company’s shares seem reasonably priced. The stock trades at an earnings multiple of 17 and an EV/EBITDA multiple around 8. Sales have grown better than 5% per year for the past three years.

But Kewpie’s much smaller competitor is a better bargain. Kenko Mayonnaise (2915.T) is a distant second in the Japanese market with FY 2025 sales of ¥91.7 billion – less than a fifth of Kewpie. Kenko trades at ¥1829 for a market capitalization of ¥28.9 billion ($200 million).

The stock is very cheap, trading at an enterprise multiple of 1.5 times EBITDA. Kenko carries just ¥3.8 billion of debt and holds cash and securities of ¥21.3 billion. The stock has declined 23% from its 2024 peak. I believe Kenko trades at a market price that is half of its intrinsic value.

I performed a valuation of the business using an earnings power valuation method (EPV) which capitalizes free cash flow at an appropriate discount rate – the weighted average cost of the company’s capital.

First, I normalized operating income at a 2.94% margin which represents the average for the past five years. The resulting ¥2.7 billion of operating income was adjusted by subtracting taxes and adding ¥2.4 billion of depreciation. Next, deductions were made: ¥822 million for capital expenditures and ¥206 million for working capital. The sum of ¥3.25 billion is Kenko’s normalized unlevered free cash flow.

The denominator in the value equation is 7.72%, a figure representing the weighted average cost of capital. The market value of Kenko’s debt accounts for 10% of the company’s capital. Under current bond market conditions, the after-tax cost of debt is 1.78%. The cost of equity was computed at 8.4%. This represents a 6.91% premium to the current Japanese 10-Year bond yield of 1.5%. The capitalized gross value for Kenko at a weighted average rate of 7.72% is ¥42 billion.

Cash and securities were added to this amount, with deductions made for the market value of debt, pension liabilities and about ¥1.9 billion for long-term payables. The final EPV amounts to ¥57.8 billion ($400 million) or ¥3,654 per share.

The potential upside is 100%.

Too good to be true? Perhaps. Kewpie has a dominant brand, and it is unlikely that Kenko can increase market share without significant additional marketing expenditures. Kenko is a well-regarded product and it is popular in the Kansai region which includes Osaka, Kyoto and Nara, but it’s customers aren’t fanatics.

There’s also the problem with the aging domestic population. Japan’s population is shrinking. Kewpie has begun to carve a path to global growth, but the same can’t be said for Kenko. Where will growth come from?

Kenko has also suffered from erratic financial results. Operating margins have ranged from 5.3% in the most recent year ended March of 2025, to barely north of zero in FY2023. Returns on capital are in the low single digits.

I am also troubled by the possibility that Kenko’s free cash flow doesn’t accurately reflect the cost to maintain the plant and equipment. Depreciation is double the amount spent on capital expenditures. As Japan finally shakes off the curse of deflation, shouldn’t capital expenditure costs match or exceed depreciation levels?

Finally, corporations may finally be exiting the dark tunnel of deflation only to stumble into the harsh light of higher interest rates. Japanese yields have almost doubled since October, rising about 70 basis points. This is a stunning move. A massive unwinding of Japanese credit could lead to a serious fiscal reckoning and a recession. At the very least, higher rates could exert a gravitational pull on levitating stock prices.

Despite all of these concerns, Kenko still holds investment appeal. Kenko offers a wide margin of safety. Mayonnaise has become a central component of Japanese cuisine. Owning the second-best brand seems like a tasty choice… especially when its on sale.

Until next time.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by

Subway

In the 1950’s, some of Ben Graham’s disciples would exchange investment ideas. They weren’t managing vast amounts of capital at the time, so investors like Bill Ruane and Walter Schloss might pass along a thesis about an undervalued business to Warren Buffett and vice versa. They called the practice “coat-tailing.” By teaming their resources, their coordinated efforts might trigger a change at a company. New leadership, asset sales, dividends, etc. By the 1960’s Buffett kept his ideas to himself. He was wealthy enough to hoard his best plans.

Police patrolling a Bronx subway in 1981. Martha Cooper, Time Magazine

I am coat-tailing this week on the research of Altay Capital, a value investor with a focus on Asian companies. Altay recently posted a compelling investment case for Kinki Sharyo (T.7122), a Japanese manufacturer of railroad vehicles based in Osaka. With a market capitalization just below ¥10.5 billion ($72 million), the company is primarily focused on light rail and subway passenger vehicles. The domestic Japanese market accounted for 69% of sales in FY 2024, but their work can also be seen riding the mass transit systems of Los Angeles, Boston, Dallas, Seattle and Phoenix. Kinki Sharyo delivers cars to the Doha and Dubai metro systems as well. Altay Capital believes that the company is a candidate for a full takeover by its parent, Kintetsu, which holds over 40% of the stock.

Kinki Sharyo is incredibly cheap. Trading at an EV/EBITDA multiple of 2x, the company could be worth more than double its current share price. I won’t elaborate on the characteristics of the business, or some of the pros and cons. Altay’s article provides all the rationale you need. My intention here is to simply offer a few more calculations to bolster the investment thesis.

I am attracted to the real estate. Kinki Sharyo generates about ¥700 million of net income annually from commercial properties in Osaka. The fair value of these assets amounts to approximately ¥10.25 billion. There’s more. Kinki Sharyo just closed the books on fiscal year 2025 in March with over ¥6.3 billion of cash on the balance sheet. The company holds another ¥6.3 billion of liquid investment securities. On the liabilities side, the business has debt and leases of ¥5.4 billion and pension liabilities of ¥2.9 billion. We haven’t looked at the railway business yet, and the net assets already exceed ¥14.5 billion.

Per my customary practice, I employed an earnings power valuation of the business. First, I normalized operating income over six years. This included the loss-making year of the pandemic in 2020 as well as the surge of deliveries in 2024 which produced ¥4.3 billion of operating income. FY 2025 EBIT was 234 million yen. The six-year average is ¥1.265 billion. Next, ¥708 million of real estate income was subtracted, along with taxes, and just over ¥1 billion representing FY 2025 capital expenditures. ¥1.3 billion of depreciation was added back to arrive at normalized unlevered free cash flow of ¥635 million. This numerator was capitalized by 6.54%, a figure representing a weighted average cost of capital.

The WACC was computed using a cost of debt at 2.65% and a cost of equity of 8.75%. Although Kinki Sharyo pays barely more than 1% for its debt, I employed a rate that is 119 basis points over the current Japanese 10-year yield of 1.46% for the debt which accounts for 34% of capital. Kintetsu is rated BBB, so I applied the US spread to the Japanese yield. On the equity side, I took the risk premium for Japanese equities and default spread for Japanese bonds of 6.91% and added it to 1.46%. I figured 69% of equity is attributable to Japanese sales. The remainder was weighted towards US equity costs and about 12% for revenues derives from the “rest of the world”. My cost of capital feels a little low, but borrowing in yen keeps it that way.

The value of the rail business, by my computation, is just about ¥9.7 billion. This is rabout 85-90% of the depreciated book value of the company’s plant and equipment. By comparison, Alstom of France, trades at about 85% of book value. I added cash and securities, the Osaka real estate, and subtracted debt and pensions. To be conservative, I subtracted ¥3.5 billion of the cash because it is pledged as collateral for contracts in progress. The net calculation sums to ¥20.8 billion, or ¥3,022 per share. Kinki Sharyo is trades for half this amount. A true bargain.

The railcar business is cyclical, capital intensive and subject to the challenges of winning a new contract and delivering products over many subsequent months. The risks of an underpriced bid, production delays, raw material expense fluctuations and potential warranty claims all weigh on Kinki Sharyo. There is no denying that sales declined significantly in FY 2025 and there is little visibility into future bookings. The large infrastructure spending boost to transit systems in the United States is over. Maintenance contracts in Japan and growth in emerging markets will be needed to drive future sales. Despite these challenges, the share price reflects a wide margin of safety. The stock trades for less than the sum of investment assets on the balance sheet.

Tulip Mania or Dollar Hedge?

Is cryptocurrency a fantasy like Dutch tulips of the 1630’s, or is it a legitimate store of wealth? On the legitimate side would be the sophisticated blockchain system of accounting ledgers which offers a technologically advanced method of universal counting, sorting, and exchange. Then you have the uncertain future facing a US dollar eroded by inflation and foreign distrust. Gold has served as a store of value for centuries. Perhaps cryptocurrencies are the modern equivalent.

The case fo crypto-mania seems easier to prove. The original bitcoin was “minted” by a computer algorithm generated by an unknown programmer called Satoshi Nakamoto. The ”currency” has proven to be useful for criminals, but few others. And then there’s the world of “memecoins”. These are tokens that their creators sell to the public which represent, well, nothing at all. Exhibit A: Fartcoin. All the fartcoins in existence amount to $1.25 billion. We’re talking real money. The idea that something known as fartcoin has a value higher than zero is pure madness. Imagine presenting your financial statement to a bank and listing Fartcoin as an asset.

If you haven’t read any of Matt Levine’s columns, you need to. Nobody is better at separating the ridiculous from the sublime in modern finance. One of his favorite topics is the ability to buy stock in publicly traded companies that hold bitcoin. The most famous of these entities is MicroStrategy (MSTR), which is now known simply as Strategy, and led by the visionary (and/or delusional) Michael Saylor. If you buy stock in Saylor’s company you own shares in a business valued at $109.3 billion. Strategy holds bitcoin in the aggregate amount of $38.76 billion. They issue new shares, and they use the proceeds to buy bitcoin. On and on it goes. A perpetual money machine.

But there’s an obvious problem here. When you buy a share of MSTR, you are buying $1 of bitcoin for $3. Why would a rational human being undertake such a transaction? Why not just buy $1 of bitcoin for $1? Well, maybe you think that Saylor and his management team have better insights into managing this “portfolio”. What would you pay for such a brilliant management team?

Well, Berkshire Hathaway might be one comparison. Despite Warren Buffett’s retirement, Berkshire has some of the finest managers in the world. A lot of people talk about Warren Buffett’s capital allocation skills, but few discuss his ability to spot a talent. Berkshire Hathaway trades at a price to book value of 1.69x. It has never exceeded 2 times. We aren’t even talking about the dilution problem with MSTR. Berkshire hasn’t issued new shares in a generation. MSTR is constantly issuing $3 shares to buy $1 of assets.

Well, maybe you would rather hold bitcoin through a company because you trust the stock market more than the crypto market. You’re not sure you want to open an account at Coinbase. You might be a little nervous reading about the periodic hacks that occur at these “financial institutions”, or the horror stories of “lost wallets”. There are alternatives here too. One could simply buy the iShares bitcoin trust managed by BlackRock. Trading with the symbol IBIT, the ETF has a market capitalization of $56.5 billion. It’s price to “book” is 1x.

As Jim Chanos has pointed out, there is a way to hold these opposing views through arbitrage. You can believe that cryptocurrency has long term value and also believe that a speculative mania of vast proportions is currently underway. How does one go about making money from such cognitive dissonance? The trade would be to sell short MSTR while simultaneously holding a long position in IBIT. Over time, these contrasting positions should converge.

The Jam

You might have figured out that Paul Weller is one of my music heroes. The Jam released Down in the Tube Station at Midnight in October of 1978 and it reached 15 on the UK singles chart. It’s one of my favorite tracks and probably in my top five by The Jam. It’s definitely the best song I know about riding subway trains. I’d hate to see terminal decline set in for the El or MTA. It’s a convenient way to travel in a big city. As long as you don’t encounter “thugs who smell of pubs, and Wormwood Scrubs“, that is.

Until next time.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by

Sir Larry

We never found out whether Lawrence Wildman successfully turned around Anacott Steel. He sure was serious about it. You don’t drive all the way out to The Hamptons to make a deal with Gordon Gekko on a Friday night unless you’re serious. But did it work? Aside from Nucor, there haven’t been many happy endings for American steel companies. We’ll never know. My guess is that Sir Larry probably extracted some union concessions, sold some assets and limped along for a few years. Lakshmi Mittal probably bought Anacott a decade later for a pence on the pound.

Of course, you can’t know the future. Wildman thought he was buying an industrial stalwart at a bargain price. He couldn’t have foreseen the collapse of the Soviet Union and the opportunists like Oleg Deripaska and Mittal picking over the crumbs of a failed industrial empire. They would produce steel in Eastern Europe at a fraction of Western costs. He couldn’t know that Deng Xiaoping was about to unleash one of the greatest economic miracles in modern history. Nobody in 1987 could have foreseen all the cheap Chinese steel that would eventually flood the market.  

So it goes with investing. You have some theories about the future, you can find some businesses that appear to be selling for less than (or more than) their intrinsic value, you make some assumptions about interest rates, and there you have it. Only time will tell how the market weighs your decisions. Time can mean decades or minutes. There is no certainty.

I decided to assess my own book of business. I’ve looked back over my articles since the summer of 2024 and charted the results. The results are decent. Since July 1 of 2024, the S&P 500 is up 2.67%, my selections have delivered a 6.6% return on a weighted average basis. It’s not exactly 1950’s Buffet performance, but it’s enough to keep me going.

I had two big misses in my “circle of competence” – real estate. I was long Peakstone Realty Trust (PKST) and short Welltower (WELL). I am convinced that Welltower is one of the most overvalued real estate businesses currently selling in the public markets. Guess what? Old Man Keynes’ axiom applies here. Nobody cares. It’s senior living and you can’t beat the demographic trends. Welltower will continue to dilute shareholders with more stock sales, overpay for B assets, deliver a paltry dividend yield, and people will keep buying the stock. 

I’ve already moaned about Peakstone. They had been on a pretty good run. Paying down debt and liquidating weak assets seemed like a no-brainer. Then they went out and bought a bunch of B industrial at 5% cap rates. Didn’t see that coming.

My biggest wins came from Hong Kong. I found exceptional bargains in January. I really did well with Johnson Electric, Budweiser APAC, WH Group, CK Hutchison, and Sinopec Kantons. I still own Budweiser, Hutchison and a little Johnson Electric. WH Group was sold after the tariffs were announced and Sinopec probably doesn’t go much further with oil below $65. 

I had some decent luck shorting the AI capex boom. Lumen is down 50% and I also had nice profits on Digital Realty and Iron Mountain. I closed those shorts for some nice gains. They weren’t very large holdings, though.

There were four stocks in which I took no position. Shiseido has suffered from a decline in Chinese sales and poor margins, yet the stock is far from being a bargain. Learning my lesson from Welltower, I didn’t short Brookfield Infrastructure Partners. The company is an investment holding company that should trade closer to NAV, but it probably never will. Because, well… Brookfield. International Game Technology could have been a good short but I didn’t think it was worth the effort. I wish I had shorted Alexandria Trust. Biotech has been pummeled, and ARE is the industry’s biggest landlord.

My biggest disappointment has been following Elliott into long positions in Sensata and Southwest Airlines. Just because someone smarter than you has done something, it doesn’t mean that you should too. I had my doubts about Sensata, yet went ahead with the investment. Tariffs hurt, of course. My short position in trucker Heartland Express mitigated some of this fallout.

Finally, I am committed to Bayer for the long term. The company has the potential to improve margins, and I think RoundUp herbicide is indispensable. Patrick Industries is a long term short. A pandemic darling that has yet to fully capitulate. REX American Resources is an outstanding ethanol producer with no debt and disciplined management. It may be dead money for a couple of years, though.

By the way, Terence Stamp played Wildman in Oliver Stone’s film. A legendary actor, Stamp was fantastic as a cockney gangster in Steven Soderbergh’s 1999 film The Limey.

Until next time.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by

Pretty Persuasion

Shiseido is a Japanese cosmetics company founded in 1872 by Arinobu Fukuhara, the former head pharmacist for the Imperial Japanese Navy. Fukuhara opened a pharmacy after leaving the navy and added a soda fountain after visiting stores in the United States. In 1917, the company introduced face powder and began expanding its footprint. Today, Shiseido is one of the world’s leading cosmetics businesses with 2024 sales of nearly $7 billion.

In addition to Shiseido products, the company owns leading brands such as NARS and Cle de Peau. Drunk Elephant is among its up-and-coming marks. Unfortunately, revenues have been on a downward trend since 2022 when sales to China began to decline. The recession caused by the Chinese real estate collapse has been a problem for most luxury brands. Shiseido (SSDOY) stock has fallen by over 66% over the past five years, and the market capitalization stands at $6.4 billion (909 billion JPY).

I became interested in Shiseido when I saw that Independent Franchise Partners, the London-based activist firm, had taken a 5.2% position in the company. Japan’s notoriously sclerotic corporate culture is slowly becoming more accountable to shareholders. The company has introduced its 2026 “Action Plan” which aims to grow sales and expand margins. Changes can’t come fast enough. Shiseido stumbled to a loss of 9.3 billion yen in 2024.

The contrast with the French cosmetics giant L’Oreal is stunning. L’Oreal posted sales of $49.6 billion last year, and operating profits of $9.4 billion. L’Oreal (LRLCY) has a market capitalization of $208.7 billion and trades at an EV/EBITDA multiple of 18.6x. L’Oreal boasts a return on capital nearing 19%. Operating margins are a healthy 19%. Meanwhile, Shiseido trades for a multiple of 14.4x with much more debt than the French company.

The most glaring difference between the two glamour brands is the level of employment costs. L’Oreal generated nearly $525,000 per employee last year while Shiseido sales-per-employee amounted to roughly $250,000. Although Shiseido employees are about $30,000 less expensive per head, the overall labor effectiveness for the French company is more than 35% better.

I don’t have any insights into why such a disparity exists. Japan has a famously attentive customer service culture that may demand a higher number of sales staff. Perhaps L’Oreal outsources more aspects of their business. Whatever the case, Shiseido will have to dramatically reduce headcount if they are going to reach their stated goal of 7% operating margins.

Judging by 2024 financial results, Shiseido remains overvalued despite its protracted market slump. I used an earnings power valuation method to calculate the value of the business based upon last year’s numbers. I applied a discount rate of 6.12% for capitalization purposes. Debt, 30% of the weighting, costs Shiseido 1.64%. I estimated the cost of equity to be 8.2%, given Japan’s higher default spread and equity risk premium. On this basis, Shiseido has a value of less than 228 billion yen. The result of my equation is more punitive than illustrative – Shiseido book value exceeds 632.4 billion yen.

What happens if the company achieves the sought-after 7% margins? I adjusted the numbers and the market capitalization reaches 988 billion yen, only slightly better than the current market price. Finally, I wondered what could happen with L’Oreal’s margins. “Le Shiseido” is worth about 2.3 trillion yen – or about 150% more than its current value.

I’m pressing the pause button. There is no margin of safety at the current price, and the resuscitation of the Chinese consumer will probably take a few more years. The leadership of Shiseido recognizes the problem, but it’s not clear that the “Action Plan” goes far enough. I’m sure Independent Franchise Partners won’t find the projections sufficient for their return requirements.

Will radical changes come to Shiseido? Japan, Inc. seems serious about unlocking shareholder value. Even beleaguered Estee Lauder (EL) manages an operating margin of 8% excluding impairment and restructuring charges, so the target seems underwhelming. Shiseido has rarely delivered returns on capital in excess of the high single digits – even in the heady days of lockdown makeovers.

An opportunity may arise to own part of a 150-year-old brand which is a staple of the Asian beauty market for what it traded for ten years ago, but it will require much more than an “Action Plan”. Some day, perhaps soon, a slimmed-down Shiseido may eventually beckon from the mirror.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by

High cotton

Physics was never boring. At least not when Richard Feynman was teaching. Despite the complexity of his subjects, he kept things simple and fun. Feynman was awarded the 1965 Nobel prize for his work on quantum electrodynamics. His method for learning a topic was to be able to write about it in such a way that a 12 year-old could understand. “Anyone can make a subject complicated but only someone who understands can make it simple,” explained Feynman. That’s why I write down my thoughts, theories and formulas for various investments. To learn. To teach myself.

I fall short of Feynman’s dictum of elegant simplicity on most occasions. Never more so than my recent attempt to explain the valuation of Brookfield Infrastructure Partners (BIP) using the firm’s consolidated financial statements. It’s not entirely my fault. Understanding BIP’s organizational chart practically requires a degree in quantum electrodynamics.

I think BIP management prefers things to be as complicated as possible. BIP is a publicly traded limited partnership. They obfuscate the value of their underlying utility, transport and midstream properties through a web of holding companies and partnerships, most of which are offshore. Buffett would surely file BIP in the “too hard” pile.

BIP is far from a monolithic operating company with a series of divisions. BIP is really a loose confederation of businesses – virtually all of them joint ventures with third parties – that pass cash to limited partners only after everyone else takes their cut. BIP limited partner units trade for nearly three times book value despite only having a claim on about 16% of the equity in the collective companies.

The price is held aloft by a generous 6.23% dividend yield. I concluded that BIP limited partner “equity” is probably just mezzanine debt in masquerade. The company’s allocation of “maintenance capital expenditures” in non-GAAP “adjusted funds from operations” gives investors a flawed belief that dividends are easily supported by operating cash flows.

In short, I am coming around to the thinking of Keith Dalrymple who has produced comprehensive research on the company. He argues that such a holding company structure deserves to trade for book value, and no more. Just like the old Canadian holding company Edper, the Brookfield game is to layer debt at the asset and corporate level and shuffle cash around as needed. Dalrymple’s most recent post explains that BIP is papering over the erosion in net asset value by writing-up the value of illiquid holdings in the accumulated other comprehensive income account.

What about other investment companies? Are they trading above book value? I ran the numbers on some large European holding companies. Unlike BIP, the market capitalization for each company is less than the net value of its assets. In most cases, the discount is greater than 30%.

These are mostly multi-generational wealth vehicles for legacy industrialists which also offer shares to the public. The most well-known company is Exor, the holding company for the Agnelli family of Italy, the pioneering family behind the Fiat empire. Exor holds portions of several public and private companies, most notably Stellantis, Ferrari, CNH Industrial and Philips. No, legacy automakers do not inspire much hope these days. However, I would argue that the assets held by the heirs of the Wallenbergs and their ilk are far superior to the Frankenstein that BIP has stitched together among toll roads in Brazil, Alberta LNG factories, and Indian cell towers.

If the holding companies for some of the world’s leading industrial families trade below net asset value, why should BIP sell for a premium?

Tariff Don’t Like It

I am also not Feynman-qualified to lecture on the topic of tariffs. However, I do believe that in the long run, most countries specialize and benefit from what is known as comparative advantage. You want your Swiss making watches, your Italians making pasta, and your Mexicans making tequila. I wouldn’t drink Swiss tequila. If China is producing steel below cost and dumping it in the US, yes, tariffs should apply. But there’s a reason why Bangladesh and Vietnam produce most of our clothes now. We produced most of the textiles of the world in the 1880s to 1900s. I’d prefer to live in the 21st century, thank you very much.

I am traveling in the low country this week. A visit to Savannah got me wondering about cotton. I imagined that the end of slavery meant that the price of cotton rose dramatically after emancipation. Did higher labor costs translate into higher cotton prices after the Civil War? Could that period of history be an analog for 2025?

The opposite happened. Cotton prices dropped. By a lot. Historian James Volo has a well-written summary. There were a couple of reasons for the decline. One, English textile manufacturers responded to the wartime shortages of the American South by sourcing more cotton from Egypt, Brazil and Africa. Two, the cotton gin made production so efficient that the supply of cotton boomed. In fact, American cotton production kept rising until 1937.

What’s the lesson here? Sudden price adjustments might produce unexpected consequences. Bulgarian pasta could just turn out to be a pretty decent substitute for that pricey penne from Pisa. Robot weaving machines in Cleveland might replace millions of Bangladeshi weavers. But that manufacturing renaissance on the banks of Lake Erie? It may not be coming after all. Three programmers in an office building on the outskirts of Hyderabad may control those looms.

Prices send signals to markets. Producers and consumers shift accordingly. Where they turn their gaze is not known with certainty.

Until next time.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by

Goon Squad

Everyone wants to be unique. Elvis Costello made a career out of it. Costello’s biting sarcasm stood in stark contrast to the wave of conservatism that swept Britain in the late 1970’s and brought Margaret Thatcher to power. He might have been talking about the military, or he could have meant the anonymous office drones, or maybe he was thinking of the formulaic record company hit makers. Whomever it was – probably all the above – he knew he couldn’t be one of them.

You can be a non-conformist investor. The romantics believe that you will be paid quite handsomely like John Paulson or Michael Burry. Most of the time you end up underperforming. In the worst cases, you finish lonely and broke like Jesse Livermore.

I had aspirations of finding that iconoclastic piece of investing research when I sought to understand Brookfield Infrastructure Partners (BIP). Just as I was about to hit send, I found a major bust in my numbers. To quote the legendary bassist Mike Watt:

After correcting the error, my valuation exercise resulted in a number that was pretty close to the current market price. There’s nothing particularly wrong with this conclusion. Most of the time, markets are efficient. However, I was convinced that Brookfield Infrastructure Partners was wildly overvalued. Confirmation bias can be a hell of a drug, apparently. So, here’s my story. If you stick around until the end, you just might find some loose threads to pull that may yet prove to be BIP’s Achilles heel.

When most people discuss Brookfield, they are either referring to the giant Canadian asset fund known as Brookfield Corporation (BN), with a market cap of $91 billion, or its cousin Brookfield Asset Management (BAM), with a market cap of $22.8 billion. I’m writing about another head of the hydra: Brookfield Infrastructure Partners (BIP), the publicly traded limited partnership with a market capitalization of $13.64 billion at the recent price of $29.54 per unit.

Brookfield Infrastructure Partners posted consolidated revenues of $21 billion in 2024 among four segments: utilities, transport, midstream and data. Utilities include 2,900 km of transmission lines in Brazil and 3,900 km of natural gas pipelines in North America, Brazil, and India. There’s also smaller distribution and metering businesses in the UK and ANZ. Transport includes the Triton intermodal container business, minor railroads in North America, Europe and Western Autralia, and toll roads in Brazil. Midstream is largely focused on gas pipelines and gas liquids processing facilities in North America (primarily operated by Inter Pipeline of Canada). The data business includes fiber optic networks in North America, Brazil, and Australia, 300,000 cell towers in Europe and India, and 140 data centers. There are no synergies between these businesses. It is largely a collection of assets gathered by Brookfield Corporation (BN), and Brookfield Asset Management (BAM) which generate significant management fees.

Deciphering BIP requires a compass and flashlight. The company is structured as a limited partnership with the controlling general partner (GP) interests held by a variety of Brookfield entities. Many entities are based offshore. Certain GP interests are also owned by the publicly traded Brookfield infrastructure Corporation (BIPC). The limited partnership units trade with the ticker BIP.

Consolidated assets of the holding company amounted to nearly $104.6 billion at the end of 2024. Debt totaled $54 billion. Book equity summed to $29.85 billion. Yet, the publicly traded limited partnership units have balance sheet equity of little more than $4.7 billion. Over $20.5 billion of book equity is attributable to joint venture partners and the balance of $4.6 billion is held by general partners and preferred interests.

BIP is proud of its distributions to its limited partners. The dividend yield on offer for today’s unit purchasers is nearly 6%. According to BIP, this payout ratio is well-covered using the company’s preferred metric of distributions as a percentage of funds from operations (FFO), and as a percentage of adjusted funds from operations (AFFO). FFO is a proxy for operating cash flow. The measure adds non-cash items, mainly depreciation, back to net income. AFFO takes funds from operations and subtracts maintenance capital expenditures. According to BIP, 88% of AFFO is paid to partners. The dividend is a key component of BIPs investment appeal, and any doubt in the ability of the company to pay unitholders their quarterly stipend would surely send the share price plummeting.

The most important conclusion to draw from the financial reports is just how little is owned by the limited partners. Publicly traded units of BIP only have a claim on 15.76% of the balance sheet equity. Funds from operations tell a similar story. Consolidated revenues of $21 billion emerge as $5.67 billion of FFO. Approximately $3.2 billion of FFO is attributable to the joint venture partners, leaving $2.47 billion of funds from operations attributable to the partnership. Next, BIP deducts maintenance capital expenditures of $606 million. This leaves $1.86 billion of adjusted funds from operations (AFFO). Limited partners received 77.9% of the distributions in 2024 and general partner and preferred interests received 22.1%.

Valuation

As noted above, BIP limited partners have a claim on approximately 15.76% of the company’s equity, so I adjusted balance sheet items to reflect this percentage. AFFO for 2024 was $1.86 billion. I added the proportional interest expense attributable to the partnership to arrive at an “unlevered AFFO” of $2.4 billion. Distributions were split between general partners and limited partners, with the LP’s receiving about 78% of the total. Therefore, I assigned $1.87 billion to the limited partners. This “unlevered AFFO to limited partners” was capitalized with by dividing the amount by 8.22%, the weighted average cost of capital for BIP.

Where does that 8.22% discount rate come from? At $8.5 billion, debt accounted for 39% of capital. Interest as a percentage of total financial liabilities cost BIP 6.28% in 2024, or 4.96% after tax deductibility is factored in. Equity costs take into account the geographic diversity of BIP’s revenues. The breakdown follows: 67% North America, 11% India, 12% South America, and 10% “Other”. I used the 10-year US Treasury rate of 4.31% for the risk-free rate assumption across all regions, but I did adjust the equity risk premiums. Therefore, the North American cost of equity is approximately 8.6%, India is 14.5% and Brazil is 15.3% the balance was weighted to a cost of equity of 10.2%. The total cost of equity amounted to 10.23%.

The total capitalized value to limited partners is $22.77 billion. After subtracting $8.3 billion of proportional net debt, the net value to the limited partner unitholders is $14.5 billion, or $31.41 per share. Based on this calculation, BIP is fairly valued.

It didn’t start out this way. I thought I would crunch enough numbers to show that Brookfield Infrastructure Partners is significantly overvalued.

My run down the rabbit hole started with an article which appeared in the Financial Times on March 5th. The article questioned the opaque financials of Brookfield Corporation (BN). In a series of transactions, Brookfield appeared to utilize reserves from its insurance subsidiaries to disguise losses on Manhattan office buildings. Casting doubt upon the integrity of one of the world’s largest asset managers is a tall order, so it raised a few eyebrows when the name Dan McCrum appeared in the byline. McCrum famously exposed the $24 billion Wirecard fraud in 2018. I’ve not read McCrum’s book about “Europe’s Enron”, but I highly recommend the documentary Skandal! in which he features prominently.

The FT article from March 5 quotes a few sources who share their skepticism about the Canadian asset management behemoth and its various holding companies and subsidiaries. One, Keith Dalrymple, has written several comprehensive pieces about Brookfield Infrastructure Partners (BIP).

Dalrymple argues forcefully that the limited partnership units should trade for roughly net asset value. In his view, the market misunderstands the partnership to be a conglomerate with aggregated cash flows. In his view, BIP is merely an investment holding company which should be valued at the net value of its balance sheet. Dalrymple contends that BIP’s market value is overstated by as much as 300%.

There is no doubt that BIP’s use of consolidated financials allows the company to create the illusion of a unified conglomerate. Moreover, the liberal use of the non-GAAP accounting terms “FFO” and “AFFO” make the company sound like a real estate investment trust. The reality is far different. The web of joint ventures is a loose confederation of companies.

One of the most enlightening parts of Dalrymple’s research was his reference to Edper, a Canadian holding company that collapsed in 1995 under mountains of debt. At one point, Edper held assets of over $100 billion and employed over 100,000 Canadiens in its many subsidiaries. Its market capitalization once amounted to 15% of the Toronto Stock Exchange. Edper was the brainchild of Edward and Peter Bronfman. Exiled from the main Seagram’s Bronfman clan, Peter and Edward formed Edper in 1959. They controlled Trizec-Hahn, one of north America’s largest real estate developers, Brascan, the huge Canadian metals and mining giant, and Labatt Brewing. Control reached dozens of companies.

The brothers perfected the art of acquiring a business with borrowed money, taking most of it public while maintaining control, and using leverage to repeat the process over and over through a vast web of subsidiaries. Ultimately, excessive debt caused the empire to collapse. But the professional management at Edper didn’t disappear. In fact, EdperBrascan emerged from the ashes and changed its name to Brascan in 2000. It transformed itself into none other than Brookfield Asset Management in 2005.

Dalrymple contends that the modern Brookfield companies are using the same playbook. Looking at Brookfield Infrastructure Partners through the Edper lens changes one’s understanding of the limited partners: Although they are technically participants in the equity structure of the business, they have no voting authority. As long as BIP can pay the distributions, the units trade for a price that is three times as high as the value of its underlying assets. This expensive currency a useful tool for adding future joint ventures to the BIP umbrella.

In a sense, Brookfield is borrowing money at 6% interest under the guise of “equity”. It’s an especially good deal to be the general partner in this structure. After all, thanks to incentive payouts, general partners collected 22% of the distributions despite having a claim on less than 1% of book equity. Then there are the management fees. Brookfield earns 1.25% of the market value of all classes of partnership units plus recourse debt at the holding company level. Management fees were nearly $400 million in 2024. Add the $363 million of general partner distributions and you have proceeds to the parent companies that exceed 4% of revenues. This is a lucrative arrangement for BAM.

The area that bears further scrutiny is the use of maintenance capital expenditures to manage adjusted funds from operations. BIP reports that AFFO taken as a percentage of invested capital results in a return on capital between 14% and 15% over the past two years. I wanted to know if the overall company had equally stellar returns on capital. I decided to reverse engineer an FFO for the entire company. I took FFO attributable to the limited partnership and added back the FFO attributable to non-controlling interests. Let’s call this “global FFO”. Next, I took the percentage of limited partner FFO to global FFO for each year. Then I divided the maintenance capital expenditures attributed to the partnership by this percentage to come up with a “global maintenance capital expenditure” amount. Finally, I subtracted the global maintenance capital expenditures from the company wide consolidated FFO amount to calculate a “global AFFO” number. The return on capital was less than 10% on this company-wide basis.

I may be way out over my skis on this hypothesis, but one can envision a scenario where BIP maintains the illusion of strong performance by adjusting the maintenance capital expenditures in such a way to increase AFFO to the LP’s. The maintenance capital expenditure gray area could be rather fuzzy. How many accountants are questioning the useful life of a toll road in Minas Gerais, a cell tower in Kolkata, or a pipeline valve in Thunder Bay?

Finally, I would also highlight the growing weight of debt at the company. Leverage now exceeds 180% of book equity. Interest coverage defined as FFO-to-interest expense has steadily declined from over 5x in 2017 and 2018 to 2.75x last year. There’s plenty of coverage, but the margins are shrinking. Once again, the Edper playbook is at work. Not only is non-recourse debt present at the joint venture level, BIP has added $4.5 billion of corporate debt with no assets to back it up.

So where do we stand? Capitalizing unlevered AFFO gets you to a valuation in line with the current market price. This is reasonable, but its also the game that BIP management wants you to play. They want you to value the steady dividend and take their estimation of cash flows attributable to limited partners. A more cynical view is that the holding company is an illusion. The unified financial statements are possible because of intricate partnership control mechanisms. The company exists only on paper. The confederation of assets pay lucrative management fees, and as long as the dividend remains intact, few will question whether the company deserves to trade for three times its net book value.

Until next time.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by

No Regrets

I decided I needed a soundtrack for this week’s article. The theme is regret – the feeling that you wish you could change something that’s already happened. Edith Piaf laid the mark down. She had no regrets at all. Defiantly, she announced:

Je repars á zéro. Non, rien de rien. Non, je ne regrette rien!

Non, je ne regrette rien (No, I Regret Nothing) topped French charts for seven weeks in 1960 and became more famous for its use in countless movies since. Edith is musical tonic for the gin of regret. Still feeling guilty about that nice guy you ghosted after you found out he owned six cats? Edith at full blast will fix that.

Need a song that shows a little remorse, but still basically says “f*ck ’em”? Leave it to Ol’ Blue Eyes. In 1969, Frank Sinatra crooned with feigned modesty:

 Regrets, I’ve had a few. But then again, too few to mention… And more, much more than this, I did it my way.

Artists were more introspective in the post-Vietnam era. Regret began to fill the airwaves. Take the easy-going beach classic Margaritaville by Jimmy Buffett. The 1977 ballad seems innocuous on the surface. Tequila, salt, sand and sun. But don’t let those steel drums fool you. Margaritaville, the anthem for an entire cult following, is all about regret. Jimmy Buffett is basically drowning his sorrows because he knows he blew his chance at true love.

I know it’s my own damn fault.

By the 1990’s, Regret was on full display. All Apologies by Nirvana immediately comes to mind, but I prefer Pearl Jam’s Black for its gut-wrenching agony.

I know someday you’ll have a beautiful life. I know you’ll be a star in somebody else’s sky. But why, why can’t it be. Oh, can’t it be mine?

Need more? Johnny Cash covered Trent Reznor’s Hurt:

If I could start again. A million miles away. I would keep myself. I would find a way.

That’s some painful regret right there. If you’re reaching for the tissues, let’s close our little musical journey on a lighter note. Taylor Swift’s, Back to December:

It turns out freedom ain’t nothing but missing you.

Ah, that’s better.

Regret is a dish served cold in Leverkusen, Germany. If you call Bayer headquarters and get placed on hold, you probably have to listen to Radiohead. The regret of which I speak is the 2018 purchase of Monsanto for $63 billion. It has been nothing short of a disaster for the venerable aspirin-maker which dates its founding to 1863.

Bayer operates in three segments: Crop Science (2024 revenues, €22.3 billion), Pharmaceuticals (€18.1 billion), and Consumer Health (€5.9 billion). Crop Science features the RoundUp herbicide franchise and DeKalb seeds. Pharmaceuticals offer a wide range of treatments with success in cardiology and women’s health. Consumer Health includes the famous Aspirin brand as well as Aleve, Claritin, MiraLax, and AlkaSeltzer.

The Crop Science business presents the largest challenge. Between 2019 and 2024, Bayer has taken over $13 billion in goodwill impairment charges. The company has accumulated over $19 billion for litigation expenses. The problem has been claims that RoundUp, the indispensable weed-killer, causes cancer. Monsanto has reached settlement agreements on nearly 100,000 lawsuits for approximately $11 billion and estimates that 58,000 cases remain. However, Bayer won a significant victory last August when the US Circuit Court of Appeals ruled that Federal law shields the company from claims at the state level. The court rejected a plaintiff’s claim that Monsanto placed farmers in danger by failing to place a cancer warning label on the product. The ruling conflicts with other decisions and leads to a belief that the commerce-friendly US Supreme Court could soon weigh in and reduce Bayer’s liabilities.

The Pharmaceutical division faces an urgent need to replenish its drug pipeline. Xarelto is Bayer’s bestselling drug, but its patent expired in 2024. Generics have started to cut into sales of the anti-coagulant. Xarelto sales topped $4 billion in 2023 and declined to $3.5 billion in 2024. The top 15 medicines accounted for $15.3 billion of sales, or 85% of the pharmaceutical segment. The next best performer is Eylea at $3.3 billion and 1% annual growth, and Nubeqa at $1.5 billion and 73% annual growth. The drugs are for retinal diseases and cancer treatment, respectively. Only a German company could withstand the irony of producing medicines to cure cancer while simultaneously making a herbicide that is a carcinogen. Somewhere, Friedrich Nietzsche is having a laugh.

Bayer has two missions: clean up the Monsanto litigation and create a more robust pipeline of pharmaceuticals. Bill Anderson, a native Texan, was hired in 2023 to lead Bayer. Anderson is a drug industry veteran, having previously run Genentech’s oncology, immunology and opthamology divisions. He later served as CEO of Genentech, a subsidiary of the Swiss drug-giant Roche, and ultimately ran Roche’s entire pharmaceuticals division. Given Anderson’s background expertise, there is speculation that once the RoundUp litigation has been arrested, the crop sciences business could be sold.

What we need to know is whether or not Bayer has the makings of a good value investment. For all of Bayer’s problems, this is still a multinational company that generated $4.5 billion of free cash flow in 2024. If you can handle the rocky ride ahead, Bayer could prove to be a very lucrative investment with a great deal of upside.

Shares trade on the DAX for about €23, giving the company a market capitalization of €22.6 billion, or $24.5 billion. American investors can buy ADRs with the BAYRY ticker for about $6.30 apiece. The company recently closed the books for 2024 and posted €46.6 billion of revenues, a decline of 9% from 2023. Operating income was €3.5 billion, with operating margins collapsing from 17.2% in 2023 to just below 7.5% in 2024. Mr. Anderson faces a stiff test.

Leverage is a concern. Over €40.8 billion of debt and leases weigh heavily. The board responded to the threat of losing Bayer’s BBB rating by eliminating the company’s hefty dividend which preserved about $2.4 billion last year. Debt was reduced from 2023’s level of $45 billion and is now on par with 2018 levels. Management is keen to reduce the debt further.

I decided to value Bayer using the preferred tool in Bruce Greenwald’s kit – a calculation of earnings power value (EPV) by taking normalized and unlevered free cash flow and dividing it by a percentage rate which reflects the company’s cost of capital. Using 2024 numbers, I calculated Bayer’s intrinsic value to be approximately €68 per share, or nearly three times its current trading price.

There are three items of note: First, I capitalized Bayer’s annual R&D spending which has hovered between €5 and €7 billion per year. The adjustment adds about €250 million to the annual income. Second, I made the computation of the weighted average cost of capital with a sledgehammer rather than a scalpel. Debt is fairly straightforward. As a BBB rated company, Bayer can borrow at 5.7% in the US market. I chose the US risk-free rate rather than the German bund rate that is about 150 basis points lower. For the equity (35% weight), I employed a 10% risk premium over our 10-Year rate, for 14.3%. The WACC, therefore, computes to 7.55%. Third, I deducted €8 billion from the value as a litigation reserve for future RoundUp claims.

Unlevered free cash flow of €8.7 billion is thus capitalized to €115 billion. Subtract net debt of €36.6 billion, pension obligations of €3.3 billion and the aforementioned litigation reserve, and the net value sums to €66.9 billion after a small adjustment for noncontrolling interests. The resulting share price of €68 gives an investor a very wide margin of safety.

Next, I made an assumption that Anderson and Co. can improve margins. Even if they rise to just 12%, still well below the recent past, it produces an additional €2.2 billion of operating cash. This boosts the share price above €96. One may quickly rebut my thesis by pointing out that the company very well may need every scrap of operating leverage if the Xarelto decline is more precipitous than expected, or the drug pipeline runneth dry.

The next exercise is to break down what a split-up Bayer might look like. Here’s a preview: The Crop Science business had an adjusted EBITDA of $4.3 billion in 2024. Corteva, spun off from DuPont in 2019 has a market cap of $41.5 billion and an EV/EBITDA multiple of 15. Even a 12 multiple would value Bayer’s agriculture division at €51.6 billion. Something to ponder.

Litigation is no way to run a business. If an investment thesis relies on a favorable ruling from the Supreme Court, you’re already on shaky ground. But Monsanto’s RoundUp isn’t like tobacco. It’s not a leisure product. RoundUp is an essential tool for the farming industry. Glyphosate is so effective, many farmers fear that it may disappear from the market and lead to replacement by cheap knock-offs from China which are likely to be unregulated and riskier to one’s health. RoundUp is not going away.

Things are looking better in Leverkusen. Even their fußball team, Bayer Leverkusen won the Bundesliga in 2024. It’s the first time a team other than Bayern Munich or Dortmund won since 2008. So, they’ve got that going for them, which is nice.

Hat tip to my friend Guillermo who hails from Vigo, Spain and put me onto the Bayer value story. Until next time.

DISCLAIMER

The information provided in this article is based on the opinions of the author after reviewing publicly available press reports and SEC filings. The author makes no representations or warranties as to accuracy of the content provided. This is not investment advice. You should perform your own due diligence before making any investments.

/by