Thoughts While Sitting in Chilean Traffic

Sometimes good investment ideas are stupidly obvious.

I recently read about Mark Lightbown, who used to run the Genesis Chile Fund. Author John Train described him as a quirky and well-mannered Englishman who traveled with a shopping bag full of his effects, on the theory that no airline would ever make him check it.

Anyway, in 1990 after Pinochet stepped down, Lightbown moved to Santiago to launch the fund and take advantage of a potential Chilean recovery. As he settled in, he noticed the number of trucks delivering Coca-Cola to restaurants in Santiago. Digging a little deeper, he found that Coke consumption in Chile was widespread. So he thought, as incomes improved and Chile rebounded, Coke ought to do pretty well.

As it turns out, the local Coca-Cola bottler, Andina, was a publicly traded company. He read the annual report and visited the company. The office was on the ground floor of the bottling plant. It was functional, not an ostentatious Greek temple — a good sign. The general manager, a man named Eulogio Pérez-Cotapos, was pleased to see him. He didn’t get many investor visits. Pérez-Cotapos told him about what Andina was trying to do and that he expected volumes to grow 10% per year and profit margins to improve as more volume improved the efficiencies of the plant.

Sounds like a great story, right? Yet Andina was trading for four times earnings. And it had 60% of the soft drink market in Chile. Lightbown bought a million dollars’ worth of stock. Ten years later — having not sold a single share — his stake in Andina was worth $70 million. That’s a 70-bagger in a decade.

It worked out even better than he hoped because Andina created new products (such as fruit juices) that it didn’t have when Lightbown made his first investment. The fruit juice business actually grew even faster than the soft drinks.

It all sounds so easy now. Of course, buying a Coca-Cola bottler was a good idea! Yet Andina lingered at four times earnings when Lightbown bought it. Nobody wanted Andina. He recalls a local broker who tried to talk him out of buying it. Why? First, the company had not grown for years. As is typical for many investors, the broker looked backward, instead of forward. And second, Pepsi was moving into the market and an advertising war ensued. This made locals worry about sleepy Andina holding up its profit margins in the face of such an onslaught.

This brings us to a counterintuitive point Lightbown makes. “Very few people think in the same terms as a foreign investor.” Which means, curiously, that locals sometimes overlook a great idea because it is in their backyard and they hold certain prejudices that are slow to adjust to a new reality.

I don’t know what happened to Lightbown or the Chile Fund since. It doesn’t matter. The story serves as an example of the power of a firsthand observation — and a simple one, at that.

Today, I doubt such an easy opportunity exists in Chile. It is a fairly developed market these days. But you never know, so I am here to explore a little and see what’s what. One easy firsthand observation struck me as I drove around Santiago. There are an awful lot of cars. Traffic is thick.

Wherever I go in my travels, I can’t help but notice how many cars are on the road. In the last 12 months, I’ve been to South Africa, Colombia, Vietnam, Thailand, Cambodia and now Chile. Buying a car is one of those basic things nearly everyone does when they can afford it. This leads to an obvious conclusion: The number of cars on the world’s roads will continue to rise as the emerging markets close the gap with the Western world.

This brings us to the auto parts suppliers.

Mario Gabelli, the famed investor behind Gamco, is one who gets it. I like the way Gabelli thinks, and I count him among my favorite investors. In the latest Barron’s Roundtable, Gabelli hit on this theme:

On a global basis, about 74 million cars will be sold in 2012, including 13.8 million in the US, reflecting a significant cyclical recovery. There are approximately a billion cars on the road around the world, including 240 million in the US. But the big growth will come from China, which had 8 million car sales in 2007 and will have 20 million in 2013. How can I make money on this?

Well, all those cars need parts. Gabelli likes a trio of plays: Genuine Parts, Navistar and Dana Holding. He didn’t mention Federal-Mogul (NASDAQ:FDML) this time around, but his firm is the third-largest institutional holder of the stock. Clearly, the old wizard likes the makers of parts for cars and trucks. I see a lot of value here, too.

Generally, investors like to go where the growth is. You have that in the automotive world. Growth of production just based on the platforms in place and current expansion plans should be strong out to 2015 in emerging markets. But it’s not like North America is a slouch here, either. North American production should grow nearly 7% per year. Only Europe is really sluggish, at 3.3%.

The problem with growth is that you usually have to pay for it. Not so among the auto parts suppliers. They are all pretty cheap on earnings and cash flow.

And these companies will be sitting in a really sweet spot in the global economy over the next several years.

Regards,

Chris Mayer,
for The Daily Reckoning