Fabrice Taylor, CFA, publishes the President’s Club investment letter. His letter and The Globe and Mail have a distribution agreement.
Think of the gold rush and you’ll think of rags-to-riches stories about men who took a risk and made big money fast.
And that’s more or less accurate except that the risks weren’t that big, the money not quite as rich nor as fast. And, most important, it wasn’t the gold miners who made it. It was the people supplying them with pickaxes, mules, booze and entertainment.
That’s why I use the term “pickaxe” stock to describe businesses that flourish during a resource boom without being directly exposed to that big, binary resource price risk – by binary I mean you either make it or you don’t.
During, say, the Klondike, miners either made a pile or nothing. They had to get lucky. But the pickaxe salesman sold every miner, regardless of his luck or success, the tools they needed. He wouldn’t make as much as the one or two miners who really struck it rich. But he’d still make a lot, and certainly far more than the average guy – and with less risk.
I hardly ever invest in resource stocks. I don’t understand them, rarely do well with them and even when I do I know deep down it’s mostly luck, even though I’d like to call it brains.
But pickaxe stocks? They’ve made me a pile, and it wasn’t luck. Here are a few examples that will give you some idea of how to find them:
Oil companies are spending tens of billions in northern Alberta developing the oil sands. They are not making particularly good money doing it. Suncor’s shares, for example, have cost investors 40 per cent over the past five years. But continue to spend they do, notwithstanding eroding economics. As they spend, they keep buying things they need to build – and the prices of these things don’t go down with oil prices.
One stock we’ve done very well with is Athabasca Minerals. Although it sounds like a resource play, it’s not really. It produces gravel, managing a pit for the government, where it earns low-risk service fees, and running its own pits, which are a little riskier but less so than producing heavy oil because gravel don’t travel – if you have it where it’s needed, you make a pile of money. And it’s very much needed in Fort McMurray. Think of all those roads in all those mines – they’re made of gravel. Athabasca also rents out some land to a company that operates worker camps. Its customers can make a lot of money or very little money but they’ll need gravel and they’ll need it from this company.
Gold mining is an even worse industry than heavy oil. How many gold producers make money? I mean, real money? Not many. But they raise money easily, and spend it lavishly. The employees make a lot, the contractors are happy, but the shareholders? Not so much. Nordex Explosives doesn’t mine gold but it does supply the blasting that’s required to get it out of the ground. Again, gold mines can make a little, or a lot, but whatever the case, they need to spend money to blast rock and the price of the explosives doesn’t move with gold prices.
Nordex is based in the middle of the gold belt, with a plant that makes a high-quality product superior to that of major competitors. And here’s an interesting thing about geology and economics: The higher the gold price, the lower the grade of rock that can be mined at a profit. But mining lower-grade rock means you have to blast a lot more rock to make an ounce. More effort for the gold miner, more profit for Nordex.
Pickaxe stocks don’t have to be quite so literal – there can be a more figurative meaning, in the sense of a purveyor of a good or service that makes a bigger trend possible. A lot of investors play emerging markets for growth, buying indexes or big-name Indian, Brazilian or Chinese stocks. But with currency exchange rates, political issues and varying accounting standards, those better returns come at a risk.
A pickaxe stock in this context is Loyalist Group, which brings foreigners to Canada to learn English. Emerging economies have to teach their workers to speak English, the language of business. The more these countries grow, the more their populations want – need actually – to learn English. Again, investors benefit from the underlying trend without the underlying risk. I own all three of these and plan to hold them for exposure to these trends without the risk.
One thing about pickaxe companies is that they tend to be smaller than the businesses or industries they supply. To many, that implies higher risk. While smaller is generally riskier, I’m not convinced they’re that much riskier than the underlying investment idea. The return, however, is generally many times better if you pick the right ones, more than justifying whatever added risk you take.