In the Commodities space, The low cost moat is the 800 pound gorilla,
Low cost moat
A low cost moat is when a company has a cost of production that is significantly below the cost of production of its competitors. An example is a company able to produce a good at a cost of 5 compared to the average competitor which can only produce at a cost of 8. Low cost moats are the strongest competitive advantage in the commodities space, as there is no differentiation between different products. At an example would be bricks, sand, steel, coal. Where the product quality is standardized. A buyer would depend heavily on pricing in order to determine their purchasing decision.
In an environment where the price of the commodity is high, the low cost producer is able to obtain outsized profits, and is able to grow at a faster pace than their competitors, provided that they maintain their cost advantage. In an environment where the price of the commodity is low, they are able to operate at a slight profit or expand market share while their competitors are struggling. Even grow by purchasing distressed assets.
It is like a 5 foot person and a 7 foot person standing in an empty pool when the pool starts to fill up. Once the water reaches 6 feet, the 5 foot person will be jumping and treading water, while the 7 foot person would not need to do anything. The 7 foot person is like the low cost company, while the 5 foot person is like the avg market competitor. As the water rises above 7 foot. The 5 foot person would have become so tired they would no longer be in the market. Having exited, the supply in the market would start to contract, and the low cost competitor would be able to increase their market share.
In good markets, the low cost producer would grow faster than the avg producer, in bad markets the low cost producer would be taking market share and building a warchest while all other competitors are struggling.
of lower Delivered cost to consumers and a tax free environment vis a vis other producers.
Let us look at 3 companies. One a hypothetical example, and 2, actual companies.
A visual example
25% tax
Company A.
operating costs 8
Commodity price 10
profit 2
Company B
Operating costs 6
Commodity price 10
profit 4
extra 100% difference in profit
After Corporate tax break (25%)
Company A
profit 1.5
Company B
4
extra 167% profit.
How does this translate into Owner earnings/building a warchest over time?
Let us look over a period of 5 years.
Example 2
OM Holdings
OM Holdings is one of the lowest cost ferroalloy producer in the world. The factors that underpin this low cost is underlined below. The key of these factors is the captive hydropower located in the Sarawak Corridor of Renewable Energy.
Captive Hydropower
Captive Hydropower from Bakun(2400MW), Murum(944MW), Baleh Dam (1285MW)(Upcoming 2025). OMH smelter is located in the Samalaju Industrial park, which is home to a captive potential hydropower of over 20,000MW, with 8,000MW worth of sites having already been identified as viable. There is ample room for growth in low cost hydropower.
The only 2 other locations producing ferroalloys with hydropower competitive vis a vis Samalaju Industrial Park is in Iceland and Norway, both countries have steadily grown and are starting to increase electricity prices. This is particularly noticable in Iceland as noted here. Another potential region is in Ningxia, China, however no data is available. In addition Ningxia is 1,200km away from the Tianjin ports and is land locked. China also institutes a 20% export tax on Ferrosilicons as well classifying ferrosilicon as a hazardous product, thereby increasing the cost it takes to export ferrosilicon outside of China. This creates a built in margin for companies like OM Holdings.
In the past there existed an illegal operation to export ferrosilicon through vietnam in order to bypass the 20% export tax. However after the spike in illegal exports through Vietnam in 2015-2016 due to the weakening domestic market. There was a large crack down on illegal exports and the major part of these illegal exports have been shut down. This is a large positive for the global ferrosilicon market, as more than 50% of ferrosilicon production is located out of China, with China heavily subsidising many commodities, the domestic prices of ferrosilicon is generally 20% to 30% lower than the markets outside of China.
Adjacent to Major Sea Trade Routes
The Samalaju Industrial Park is located at the coastal region, this enables deep water ports to be built and provides direct access to the major sea trade routes without having to go through land logistical issues. There are no trucking nor are there train routes required. Port expenses are also partially subsidized by Samalju Port in line with the government drive to improve the Samalaju Industrial Park.
Proximity to Major consuming regions.
Ferroalloys are a key input into the production of steel. The Samalaju Industrial Park is located at regions close to the main Steel producing countries in the world
There are 4 countries that produce a lot of steel, 3 of which do not produce much ferroalloys and are required to import. These 4 countries constitute more than half of global production of steel. and are listed below. Figures are as at 2017.
Total steel production in the world (1691 million tonnes)
China (831 million tonnes) (Largest)
Japan (104.7 million tonnes) (3rd largest)
South Korea (71 million tonnes) (6th largest)
Taiwan (23.1 million tonnes) (11th largest)
Dedicated Samalaju port (Favourable port transport costs) 8KM away from OM Holdings factory.
Lower logistical costs and immediate access to seaborne raw materials and the ability to transport goods immediately to seaborne routes.
Government support 10 Year Corporate tax break
OM Holdings was able to obtain a 10 year corporate tax break. The tax break acts as a huge tailwind in the event of improving market activities, as it increases profits by 33% (assuming a 25% tax) vis a vis other competitors. The effect of these is visually outlined below. Assuming the money is not reinvested and is instead given out as a dividend.
No import and export taxes
Dedicated infrastructure in the Samalaju Industrial Park
Water, waste disposal and the required infrastructure is already in place in order to support the heavy industries, as the Samalaju Industrial park was built in order to cater for heavy industries.
No tariffs
Malaysia did not have a Ferroalloy export industry, prior to Samalaju Industrial park. As such, there have been no tariffs instituted against Malaysia, unlike countries like China, which have extensive tariffs in Europe and in US. These markets provide higher margin compared to the traditional margins due to these tariffs against most of the major ferroalloy producers.
Example 3
CF Industries.
No Corporate taxes
No land transportation costs
Near to sea ports
Cheap hydropower
No import and export taxes in Malaysia
China export taxes on ferrosilicon by China
Hazard taxes required on export of ferrosilicon from china. Translate to higher transportation costs.
A low cost moat is when a company has a cost of production that is significantly below the cost of production of its competitors. An example is a company able to produce a good at a cost of 5 compared to the average competitor which can only produce at a cost of 8. Low cost moats are the strongest competitive advantage in the commodities space, as there is no differentiation between different products. At an example would be bricks, sand, steel, coal. Where the product quality is standardized. A buyer would depend heavily on pricing in order to determine their purchasing decision.
In an environment where the price of the commodity is high, the low cost producer is able to obtain outsized profits, and is able to grow at a faster pace than their competitors, provided that they maintain their cost advantage. In an environment where the price of the commodity is low, they are able to operate at a slight profit or expand market share while their competitors are struggling. Even grow by purchasing distressed assets.
It is like a 5 foot person and a 7 foot person standing in an empty pool when the pool starts to fill up. Once the water reaches 6 feet, the 5 foot person will be jumping and treading water, while the 7 foot person would not need to do anything. The 7 foot person is like the low cost company, while the 5 foot person is like the avg market competitor. As the water rises above 7 foot. The 5 foot person would have become so tired they would no longer be in the market. Having exited, the supply in the market would start to contract, and the low cost competitor would be able to increase their market share.
In good markets, the low cost producer would grow faster than the avg producer, in bad markets the low cost producer would be taking market share and building a warchest while all other competitors are struggling.
of lower Delivered cost to consumers and a tax free environment vis a vis other producers.
Let us look at 3 companies. One a hypothetical example, and 2, actual companies.
A visual example
25% tax
Company A.
operating costs 8
Commodity price 10
profit 2
Company B
Operating costs 6
Commodity price 10
profit 4
extra 100% difference in profit
After Corporate tax break (25%)
Company A
profit 1.5
Company B
4
extra 167% profit.
How does this translate into Owner earnings/building a warchest over time?
Let us look over a period of 5 years.
Example 2
OM Holdings
OM Holdings is one of the lowest cost ferroalloy producer in the world. The factors that underpin this low cost is underlined below. The key of these factors is the captive hydropower located in the Sarawak Corridor of Renewable Energy.
Captive Hydropower
Captive Hydropower from Bakun(2400MW), Murum(944MW), Baleh Dam (1285MW)(Upcoming 2025). OMH smelter is located in the Samalaju Industrial park, which is home to a captive potential hydropower of over 20,000MW, with 8,000MW worth of sites having already been identified as viable. There is ample room for growth in low cost hydropower.
The only 2 other locations producing ferroalloys with hydropower competitive vis a vis Samalaju Industrial Park is in Iceland and Norway, both countries have steadily grown and are starting to increase electricity prices. This is particularly noticable in Iceland as noted here. Another potential region is in Ningxia, China, however no data is available. In addition Ningxia is 1,200km away from the Tianjin ports and is land locked. China also institutes a 20% export tax on Ferrosilicons as well classifying ferrosilicon as a hazardous product, thereby increasing the cost it takes to export ferrosilicon outside of China. This creates a built in margin for companies like OM Holdings.
In the past there existed an illegal operation to export ferrosilicon through vietnam in order to bypass the 20% export tax. However after the spike in illegal exports through Vietnam in 2015-2016 due to the weakening domestic market. There was a large crack down on illegal exports and the major part of these illegal exports have been shut down. This is a large positive for the global ferrosilicon market, as more than 50% of ferrosilicon production is located out of China, with China heavily subsidising many commodities, the domestic prices of ferrosilicon is generally 20% to 30% lower than the markets outside of China.
Adjacent to Major Sea Trade Routes
The Samalaju Industrial Park is located at the coastal region, this enables deep water ports to be built and provides direct access to the major sea trade routes without having to go through land logistical issues. There are no trucking nor are there train routes required. Port expenses are also partially subsidized by Samalju Port in line with the government drive to improve the Samalaju Industrial Park.
Proximity to Major consuming regions.
Ferroalloys are a key input into the production of steel. The Samalaju Industrial Park is located at regions close to the main Steel producing countries in the world
There are 4 countries that produce a lot of steel, 3 of which do not produce much ferroalloys and are required to import. These 4 countries constitute more than half of global production of steel. and are listed below. Figures are as at 2017.
Total steel production in the world (1691 million tonnes)
China (831 million tonnes) (Largest)
Japan (104.7 million tonnes) (3rd largest)
South Korea (71 million tonnes) (6th largest)
Taiwan (23.1 million tonnes) (11th largest)
Dedicated Samalaju port (Favourable port transport costs) 8KM away from OM Holdings factory.
Lower logistical costs and immediate access to seaborne raw materials and the ability to transport goods immediately to seaborne routes.
Government support 10 Year Corporate tax break
OM Holdings was able to obtain a 10 year corporate tax break. The tax break acts as a huge tailwind in the event of improving market activities, as it increases profits by 33% (assuming a 25% tax) vis a vis other competitors. The effect of these is visually outlined below. Assuming the money is not reinvested and is instead given out as a dividend.
No import and export taxes
Dedicated infrastructure in the Samalaju Industrial Park
Water, waste disposal and the required infrastructure is already in place in order to support the heavy industries, as the Samalaju Industrial park was built in order to cater for heavy industries.
No tariffs
Malaysia did not have a Ferroalloy export industry, prior to Samalaju Industrial park. As such, there have been no tariffs instituted against Malaysia, unlike countries like China, which have extensive tariffs in Europe and in US. These markets provide higher margin compared to the traditional margins due to these tariffs against most of the major ferroalloy producers.
Example 3
CF Industries.
No Corporate taxes
No land transportation costs
Near to sea ports
Cheap hydropower
No import and export taxes in Malaysia
China export taxes on ferrosilicon by China
Hazard taxes required on export of ferrosilicon from china. Translate to higher transportation costs.
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