THINKING ABOUT COMMODITY COMPANIES?

"A mine is a hole in the ground with a liar on top"  Mark Twain

"As for commodities, the only consistently profitable extractive industry is dentistry"  Barton Biggs

“In an unregulated commodity business, a company must lower its costs to competitive levels or face extinction” Warren Buffett

“[In] commodity businesses, being a low cost provider is not enough of an advantage for an overweight position since the commodity price is subject to going below the cost of production for an unpredictable period of time.” Mason Hawkins

“The most important question to ask about a cyclical is whether the company’s balance sheet is strong enough to survive the next downturn” Peter Lynch

“Businesses in industries with both substantial over-capacity and a “commodity”product are prime candidates for profit troubles” Warren Buffett

“In a business selling a commodity-type product: it’s impossible to be a lot smarter than your dumbest competitor” Warren Buffett

“Charles Munger points out that in a commodity business or a business earning substandard returns ‘All of the advantages from great improvements are going to flow through to the customers .. the people who sell the machinery – and, by and large, even the internal bureaucrats urging you to buy the equipment .. and it isn’t that the machines weren’t better. It’s just that the savings didn’t go to you. The cost reductions came through all right. But the benefit of the cost reduction didn’t go to the guy who bought the equipment” Peter Bevelin

“Buying a cyclical after several years of record earnings and when the P/E ratio has hit a low point is a proven method for losing half of your money in a short period of time.” Peter Lynch

"As Peter Lynch says, stocks of companies selling commodity-like products should come with a warning label:  'Competition may prove hazardous to human wealth'."  Warren Buffett

“If a company is facing strong competition from a more efficient competitor with lower costs, it is perhaps best to utter those comforting words “no, thank you” and move on to the next candidate” Chris Browne

Peter Brandt [a veteran commodity trading adviser since 1976] has stated in regards to commodities trading below costs ... "But, you might say, this kind of drop is impossible because producers must make money. Who says?? Markets in supply surplus tend to go the production price of the most efficient producers. Plus, who would have ever believed when Crude was at $148 in mid-2008 that prices would retreat to below $40 in just six months. So take your pet macro-economic/fundamental scenario and burn it with the trash!"

“The supply curve is inverted. Most producers need to generate a certain amount of dollars; as the price falls, they will try to increase the amount sold until the price falls below the point at which high cost producers can break even. Many of them will be unable to service their debt.” Soros [on oil in 1985]

“It so happens that contemporary economic optimized life causes us to build larger and larger theatres, but with the exact same door. They no longer make this mistake too often while building cinemas, theatres, and stadiums, but we tend to make the mistake in other domains, such as, for instance, natural resources and food supplies. Just consider that the price of wheat more than tripled in the years 2004-2007 in response to a small increase in net demand, around 1 percent. Bottlenecks are the mother of all squeezes.” Nassim Nicholas Taleb

“Another way to prosper in a commodity-type business is to be the low-cost operator. But a company holding a low-cost advantage must pursue an unrelenting foot-to-the-floor strategy.” Warren Buffett

“When you’re buying a mine or a commodity producer, cost of production becomes the moat and consistent low cost of production is the way to go about it. And so what I try to do, when I look at the miners – because obviously with commodities, you have no moat – is to create a moat by choosing a consistently low-cost provider” Mohnish Pabrai   

"In the bad times, cyclical companies with heavy debt loads may well face insurmountable problems"  Christopher Browne

"We do not have a bias toward any commodity-related business. If we have any bias, it’s against." Warren Buffett

"I don’t do commodities – we like price-makers that set prices based on value added, as opposed to price takers.  In cyclical or commodity areas, you have to be right twice, on the buy and the sell. If you miss the exit, it might be awhile before it comes back around" Jeffrey Ubben

"We fundamentally believe that energy and commodities have been value destroying businesses over time. At the same time, their value tends to be driven by the price of a commodity that we have no ability to predict." Ricky Sandler

"Financial and operating leverage coupled with a cyclicalcommodity-like business can create a volatile and potentially disastrous combination" Frank Martin

"We tend to avoid enterprises that sell a commodity-like product or service (as Warren Buffett said: no one ever asks, “I want a Coke only if it comes in an Alcoa aluminium can”). We believe that our philosophy is prudent and rational. We also believe that it should yield superior returns over the long run." Francois Rochon

“Buy commodities, sell brands has long been a formula for business success. It has produced enormous and sustained profits for Coca-Cola since 1886 and Wrigley since 1891. On a smaller scale, we have enjoyed good fortune with this approach at See’s Candy since we purchased it 40 years ago.”  Warren Buffett

“When it comes to cyclical industries, using the recent past rather than the panorama of multiple cycles as your guide can lead you either to not buying at all or selling too soon. So the ability to foresee changes in cyclical industries when others don’t see them can be worth a fortune.” Jim Tisch

"When commodities are an input, often it's the same commodity for everyone else, so if economics get much better in an industry [ie commodity prices fall], it just gets better for everyone.  You'd need to find a company that has a real franchise while their input costs are going down" Ed Bosek

"Commodity businesses are not good businesses at the end of the day: they're capital intensive, the products don't have any differentiation, and returns tend to be lower over time.  We've decided that we would only get involved in commodity businesses if we can identify the low cost producer, the commodity is priced below the cost of production, and the balance sheet is clean." Dave Samra

"We're also asking if there are large, unanalyzable forces at work that could nullify the impact of any special insights we might have.  This applies to many cyclical and commodity-orientated businesses.  Very few people predicted oil prices were going to be cut in half, and this move obliterated the value of any deep insights that energy shareholders may have had on particular companies."  Adam Weiss

"Unless pricing is controlled by a cartel, commodities tend to be cyclical - very cyclical.  The proclivity of managements to develop herd instincts when deciding to add capacity is an example of the "fallacy of composition" which states that a decision or action that is rational for one or a few individuals or companies becomes irrational if a whole group of individuals or companies follow the decision or action, and the outcome of the irrationality is adverse for all"  Ed Wachenheim

"For the great majority of companies selling 'commodity' products, a depressing equation of business economics prevails; persistent over-capacity without administered prices (or costs) equals poor profitability" Warren Buffett

"If you want to create and capture lasting value, don't build an undifferentiated commodity business" Peter Thiel

“What we try to avoid is everything that is commodity in nature, particularly related to natural resources.” Francois Rochon

"We have generally avoided commodity-sensitive businesses.  With commodity businesses, it's very difficult to predict the future price of the commodity"  Bill Ackman

“In areas like basic materials and other commodity businesses, there usually just  isn’t enough of a moat, which makes it hard for us to get interested on a fundamental basis”  Adam Weiss

"Commodity businesses with heavy reliance on debt are playing with fire. One never knows how prices can change. Unless one is a low cost producer and debt-free, if prices collapse, one is likely to be in trouble." Mohnish Pabrai

"When a company is selling a product with commodity-like economic characteristics, being the low-cost producer is all-important"  Warren Buffett

"When relatively non-differentiable products are sold based on their price, the manufacturers of the products need to have low cost structures if they wish to be competitive and earn reasonable profits" Ed Wachenheim

"We are willing to tolerate cyclicality, but I don’t like to invest in cyclicals that have a history of going into a significant cash burn mode during the down part of the cycle. The cyclical businesses that we’ve invested in are such that if you look at their EBITDA and free cash flow profile, you may see a dramatic drop in sales during the period of the down cycle, but you don’t see cash burning and that’s the key differentiator." Chris Mittleman