What did Munger mean with this comment?

[MG2014]

AGM 2008:

 

Yeah. I think there’s one metric that catches a lot of people. We tend to prefer the business which drowns in cash. It just makes so much money that the main — one of the main — principles of owning it is you have all this cash coming in. There are other businesses, like the construction equipment business of my old friend John Anderson. And he used to say about his business “You work hard all year, and at the end of the year there’s your profit sitting in the yard.

 

AGM 2003:

 

Yeah. And if you take a business that is a good business, but not a fabulous business, they tend to fall into two categories. One is the business where the whole reported profit just sits there in surplus cash at the end of the year. And you can take it out of the business and the business will do just as well without it as it would if it stayed in the business.

The second business is one that reports the 12 percent on capital but there’s never any cash. It reminds me of the used construction equipment business of my old friend, John Anderson. And he used to say, “In my business, every year you make a profit, and there it is, sitting in the yard.” And there are an awful lot of businesses like that, where just to keep going, to stay in place, there’s never any cash.

 

If it's earning 12% return on capital, is he saying most of those earnings go to debt service and not to the equity holder?

 

Is he saying something about maintenance capital requirements needing to be higher than depreciation so no free cash available?

 

Is it something around a constant upgrade cycle for construction equipment because of the competitive low-barriers nature?

 

I guess I don't understand how the construction equipment business actually works

[Munger_Disciple]

What Munger was trying to say is that in some businesses you are forced reinvest all the cash the business generates to simply stay in the business at the same spot (i.e., not grow unit volumes and things like that). This happens because your depreciation charges are much lower than maintenance capital. As the old construction equipment rusts or dies, the new one you need to buy to replace it costs way more than your depreciation charges. And you are not doing more volume of business necessarily. 

This is in sharp contrast to See's Candies type business where you are swimming in cash at year end and you don't need to reinvest much if anything back in the business. 

[MG2014]

Thanks. Buffett has talked about maintenance capital being much larger than depreciation for BNSF. Why is this not the same as "all the profit sitting in the yard"? Is it because it is only a limited period of high investment (upgrade cycle), with and the rest of the time requiring less capital?

 

 

Edited July 1, 2021 by MG2014

[Munger_Disciple]

Buffett also said that you need to "adjust" reported BNSF earnings downward to come up with a true picture of its earnings power. So he obviously understands & took into consideration that maintenance capital at the railroad is higher than depreciation. Even taking this into account BNSF is a decent business unlike a construction equipment rental company. These two are very different businesses; BNSF is a duapoly with zero chance of new entrants in the market unlike an equipment rental business with almost no barriers to entry (other than wasted capital which will be earning poor returns). It is like comparing apples and elephants. 

 

Lesson: you need to take wholistic view of the businesses, not just look at one aspect. 

[MG2014]

Micron is in an oligopoly with very low chances of new entrants, but is it more of a 'construction equipment' type business? 

 

	2012	2013	2014	2015	2016	2017	2018	2019
Capex/Ebitda	104%	57%	49%	72%	181%	48%	45%	77%
Depreciation/Ebitda	131%	83%	39%	47%	93%	39%	24%	42%

Edited July 1, 2021 by MG2014

[Munger_Disciple]

I haven't analyzed Micron in detail so I have no particular insight on it. My guess is that Micron is still a commodity business that is perhaps slightly better than it used to be. I cannot imagine Micron having pricing power in negotiations with a customer like Apple.

Edited July 1, 2021 by Munger_Disciple

[ke4436]

The original Munger quote was in reference to his friend taking older construction equipment back in part exchange for new, and so at the end of the year, instead of being left with cash, his profit was in old construction equipment sitting in his yard.  In other words, the business was not really generating any free cash flow.  Thanks.

[calonego]

Does anyone know if this is in reference to John E Anderson from TOPA Equities, the donation/name behind UCLA Anderson?

 

If so - I don’t see which business of his this would be in reference too.

 

Heavy equipment dealers and rental agencies are highly capital intensive, as is some/most construction, and yet numerous fortunes have been made in both industries. 

It’s very cyclical - but a business like Ashtead Group is super interesting (Sunbelt Rentals, it’s certainly not cheap however).

 

I get where CM is coming from (I think), but the specifics would help to understand why in this particular instance (what type of business Mr Anderson had exactly).

[Gamecock-YT]

I would just think of it as an asset heavy company vs asset light company. I think you are getting too deep in the weeds looking for specifics.

[DooDiligence]

16 hours ago, Gamecock-YT said:

I would just think of it as an asset heavy company vs asset light company. I think you are getting too deep in the weeds looking for specifics.

 

Same.

 

Profits go to (edit: maintenance) CAPEX

Edited July 17, 2021 by DooDiligence
update

[calonego]

Charlie was very interested in Seritage recently and has owned a few equipment leasing businesses (Cort, Xtra).

I personally think the nuance/detail here may be interesting. 
He’s certainly owned businesses that look similar at surface to the one he has referenced so many times as being less than ideal…

Edited July 19, 2021 by calonego

[MG2014]

On 7/16/2021 at 5:51 PM, Gamecock-YT said:

I would just think of it as an asset heavy company vs asset light company. I think you are getting too deep in the weeds looking for specifics.

 

I feel, as with everything Charlie says, it's a little more nuanced. BNSF is an asset heavy business that works. I wonder if he's making a similar point to Buffett's old story about the textile business showing high IRR equipment upgrade projects, only to find out that the competitors thought the same thing about their own projects and competed any potential gains away. 

 

Similarly, if I'm renting out a crane and the guy down the street purchased the latest and greatest crane to rent out, I'm going to have to take my year's income + the depreciated crane to buy a new crane or else I'll lose all my business to his crane. I'm not really sure if that's how it actually works though

[Morgan]

12 hours ago, MG2014 said:

 

I feel, as with everything Charlie says, it's a little more nuanced. BNSF is an asset heavy business that works. I wonder if he's making a similar point to Buffett's old story about the textile business showing high IRR equipment upgrade projects, only to find out that the competitors thought the same thing about their own projects and competed any potential gains away. 

 

Similarly, if I'm renting out a crane and the guy down the street purchased the latest and greatest crane to rent out, I'm going to have to take my year's income + the depreciated crane to buy a new crane or else I'll lose all my business to his crane. I'm not really sure if that's how it actually works though

Except with certain specific equipment, the newest and best equipment is probably not such a large benefit in an equipment rental business. As long as the equipment is reliable, is available to rent that day, and is a competitive price, it’s probably good enough. 
 

Large cranes used for a technical part of a skyscraper or something might be a different story. I’m not knowledgeable about that specifically. Basically all the equipment you’d need to use the build a housing development or mall is just a commodity in my opinion. Reliability, availability and price are the determining factors. 

 

Edited July 20, 2021 by Morgan

[jasonchin]

On 7/1/2021 at 12:09 PM, MG2014 said:

AGM 2008:

 

Yeah. I think there’s one metric that catches a lot of people. We tend to prefer the business which drowns in cash. It just makes so much money that the main — one of the main — principles of owning it is you have all this cash coming in. There are other businesses, like the construction equipment business of my old friend John Anderson. And he used to say about his business “You work hard all year, and at the end of the year there’s your profit sitting in the yard.

 

AGM 2003:

 

Yeah. And if you take a business that is a good business, but not a fabulous business, they tend to fall into two categories. One is the business where the whole reported profit just sits there in surplus cash at the end of the year. And you can take it out of the business and the business will do just as well without it as it would if it stayed in the business.

The second business is one that reports the 12 percent on capital but there’s never any cash. It reminds me of the used construction equipment business of my old friend, John Anderson. And he used to say, “In my business, every year you make a profit, and there it is, sitting in the yard.” And there are an awful lot of businesses like that, where just to keep going, to stay in place, there’s never any cash.

 

If it's earning 12% return on capital, is he saying most of those earnings go to debt service and not to the equity holder?

 

Is he saying something about maintenance capital requirements needing to be higher than depreciation so no free cash available?

 

Is it something around a constant upgrade cycle for construction equipment because of the competitive low-barriers nature?

 

I guess I don't understand how the construction equipment business actually works

 

If you need an additional reference point, Tren Griffin included the 2003 AGM reference in his book (Charlie Munger - the Complete Investor). The reference was made to "Owner's Earnings" which takes into account the capex required to maintain the business's ROE.