Qualiport

[ June 26, 2000 ]

A Welcome Return

By Rob Davies (TMFEssex)

Colchester, Essex. The Qualiport discussion board has not been on my "round" of boards for some time. So when I was asked to write an article for the slot I thought I had better revisit the board to get up to speed on what was happening.

The thread about the sale of the Unilever (LSE: ULVR) holding is perhaps not too surprising. And reading it made me wonder what stocks the community would choose to select for the new version of the UK Investment Guide being written now. I forget exactly which ones have been chosen, I think they include ARM (LSE: ARM) and Tesco (LSE: TSCO).

That may sound crazy but it points out the conundrum of the OGI. It is self evident that an OGI is obvious to everyone, so everyone holds it. If everyone holds it there is no one left to buy it, in which case why should the shares go up. A truly great investment is one you buy cheaply because everyone else hates it. Then the shares rise as the appreciation of its merits, that you spotted earlier, becomes more widespread. Once it is obvious to all that this is a great share then it is time to hop off. Well, that's my theory anyway.

The trigger for the Unilever sale was its acquisition of Bestfoods and that prompted a debate as to whether investors know more about these businesses that the managers do. It is true that many companies destroy value through acquisitions, but that is not always the case.

One of my favourite companies announced a take-over last week and I can see clearly why they are doing it and what the benefit is. I know that there is no way the Qualiport will buy Rio Tinto (LSE: RIO), although I think it should, but an explanation of the logic of this deal might be instructive.

Rio Tinto is the world's largest mining company with an unsurpassed reputation in its industry. It had got to that position by a ruthless attack on costs and some very un-pyad like analysis of NPV based on long term cash flows. If a company is going to sink a billion dollars into a new mine it wants to be pretty sure it is going to make a good return. Rio has done its calculations better than anyone else in the industry and made more money as a result.

One of its key assets is iron ore mining in north-west Australia. Yes very un-sexy, very old economy and so on. But let's face most of us don't go very far with out using a bit of steel these days. That could be in a car, train, building or just a kitchen utensil. Sure growth rates for steel consumption are modest, the International Iron and Steel Institute (IISI) estimate demand rose 2% last year. Not fantastic, but about the same as Unilever's revised revenue growth forecast. But the rates of growth vary enormously and much of the demand comes from China where steel use is rising at nearly 14%. Australia is well placed to supply iron ore to China and Rio Tinto sells a lot to that country. Last year it tried to buy the operations of rival BHP to give it more scale, but was rebuffed.

So the hostile bid to buy North, announced yesterday, does not come out of the blue. North has a variety of operations but its most profitable are the iron ore mines close to the Rio's operations. But these mines are small and North wants to develop a new one, called West Angelas. And to do that it would also need to build a new railway line at a cost of over $300m. North did try to force Rio Tinto let it use its rival's existing line, but did not succeed. So, by combining the two operations, the need for a new line is eliminated and less capital is required to start the new mine. Once built it could supply the healthy Chinese market for many years.

It makes eminent sense to me. However, I am not going to pretend that mining is a high growth industry. It is not. But it is one that already has high barriers to entry and they are rising. Finding a massive ore deposit is hard. But persuading governments that you can run it properly is even harder. From memory I think it took Rio Tinto ten years to get approval for its last mine. You won't double your money by buying Rio Tinto, but I am sure it will give a good return over time. And that, to me, is one of the keys to investing. If you don't expect too much you won't be disappointed.

Related Links:
• Steel demand
• Rio Tinto
• Rio Tinto discussion board