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Too Hot to Handle!

Too Hot to Handle!

Back in June 2010, I was interviewed by Peter Switzer on the subject of coal.

Citing a commercial property construction bubble in China, I noted that 30 billion square feet, or 23 square feet of commercial office space for every man women and child in China, was being constructed on top of then existing commercial space, which was already 20 per cent vacant and suffering from 25 per cent declines in rents.

Concluding that the circumstances sounded like a bubble I was asked to comment on Peabody Energy’s $4.9 billion bid for Macarthur Coal.

Offering a lower intrinsic value for Macarthur Coal than the price being paid, I suggested at the time that Peabody Energy’s bid was an example of management making acquisitions at “stupid” prices. Adding that management is not immune to getting excited and overpaying, the prices being paid for coal stocks were implying very high coal prices being sustained for a long time.

You can watch the old interview with a much younger Peter Switzer here.

At the time Peabody made the $4.9 billion bid for Macarthur in October 2011, its own share price was US$346.00. Today it stands at just US$9.22.

Peabody’s bid was part of a frenzy of interest in Australian coal producers by foreign companies keen to secure exposure to the boom in demand for coal from Asian steel mills.

Since that time, Chinese commercial property has fallen by 50 per cent or more, coking coal has fallen to $US78 a tonne from $US330 a tonne in 2011, and thermal coal is at $US43 a tonne – down from $US150 a tonne in 2011.

In a June ’15 interview with the Sydney Morning Herald (SMH), “former Macarthur Coal chairman Keith De Lacey said although it was not obvious at the time, Peabody had undoubtedly paid too much for Macarthur.”

“I didn’t think they overpaid for it [at the time] but obviously they did but that’s just a reflection of the market at the time and what the market was valuing us at.”

And that’s the comment I want you to think about. It may surprise you that even at the highest company level, many can be led astray by an important difference between price and value.

Price is what people are willing to pay and the market will always reflect that. But value is what something is really worth and only sometimes is the market price equal to the value.

In his 1988 letter to Berkshire Hathaway shareholders, Warren Buffett wrote:

“Amazingly, EMT [Efficient market Theory] was embraced not only by academics, but by many investment professionals and corporate managers as well. Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient.”

Now take another look at this comment by Mr De Lacey published in the SMH; “I didn’t think they overpaid for it [at the time] but obviously they did but that’s just a reflection of the market at the time and what the market was valuing us at.”

When discussing the price Peabody’s management were willing to pay was Mr De Lacey citing Buffett’s example of corporate managers believing the market was efficient at ‘valuing’ Macarthur Coal?

At Montgomery today, when valuing a company’s shares, we spend a great deal of time thinking not only about what we believe the company will earn and produce, but also what is implied by the market’s price.

When the two diverge – and they frequently do – the opportunity for profit can be great. You will do very well investing when a large gap exists between price and value and you will do very well when market expectations diverge from reality.

Where do you see this occurring today?

Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.


Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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