The fight for survival in cyclical business and the business opportunities that come with it
In his last quarterly letter to investors, Ivan Martín (Magallanes Value Investors) writes:
“Cheese, butter, ships, fertilizers and cars, it’s all the same thing”
They have brilliantly profited from the same investment thesis applied to different industries: boom-bust cycles.
The basics of a boom-bust cycle
The underlying idea is very simple. High margins attract competitors that boost supply and drop prices. The companies with the lowest efficiency and/or the most leveraged go out of business. This restricts the demand and allows for margin increases, arriving to the initial scenario.
Ivan Martin says “It never ceases to amaze me how quickly greed turns to fear and fear turns to greed with almost no time in the equilibrium”
The industries most vulnerable to cycles are the ones in which companies take a while to be set up: complex facilities, permits, etc. However, this thesis can be applied to many situations. For example, a change in regulation (as it happened to milk in Europe) or widely held fear (as it happened with basic raw material when it was thought that growth in population was not sustainable).
The impact in SMEs ( Small and medium enterprises)
I’d argue that small businesses that are resilient (low leverage and efficient) are in the best position to go shopping in the bust periods. They have the possibility of acquiring close competitors with a steep discount. In fact, most of the companies that go out of business are probably SMEs that started in the boom period with leverage and can’t downsize.
For a search fund, the best time to get in is the down stage. Then, quickly prepare to deleverage and downsize to resist the bust and be ready to acquire competitors. For some companies, the understanding of the cycle becomes the most important element to thrive in an environment where many fail.