Don't Change!
Written by Paul Siluch
December 15th, 2023
“Don't change for you,
Don't change a thing for me.”
- Don’t Change, by INXS
Welcome to our last letter of 2023. The decade started in 2020, which means we are now finishing the fourth year of ten – almost halfway. The next four years will mark the peak retirement years of the Baby Boom generation and the subsequent handover of many offices, leadership roles, and wealth to younger hands.
Much has been written about the giant technological changes we are seeing happen right before our eyes. CRISPR gene-editing. Fusion power. Artificial Intelligence (AI). Many compare today’s miracles to those of yesterday - the steam engine, electricity, the internet - in how much they changed the world. These new ones will change humanity even more.
Just last week, the very first gene therapy for sickle cell anemia was approved by the US Food and Drug Administration. Sickle cell anemia is a painful life-shortening disease where a person’s red blood cells are misshapen and bent, causing arterial blocking, cardiac threats, and great pain. The only treatment has been complete bone marrow replacement.
Now, gene-editing programs the body with new instructions to make healthy cells. The first patients have lived pain and symptom free for four years. It is a genuine miracle to them.
As much as humans love progress, we also value tradition. The tried and true. What doesn’t change.
It is why Christmas is so popular. We perform the same rituals, sing the same songs, and eat the same food every year. Yes, it has evolved, but the core celebrations – religion, family, and charity – have lasted centuries.
You’d think the investment world would prefer the newest and shiniest things. One of the biggest revolutionary ideas in recent years is the electric vehicle, or EV. Tesla is the big winner here, which makes us think all the EV makers are succeeding. Hardly! We don’t read about Lordstown, Lucid or scores of the other EV makers that are dead or dying.
The truth is that investors like things that have been around for awhile. Companies that change slowly and have a competitive advantage or “wide moat”, as Warren Buffett calls it.
Here’s an example of something both EVs and gas-powered cars need, something that has been around over a hundred years. Let’s talk about the tire.
SPINNING WHEEL
Despite what many young people think, the Flintstones weren’t the first to invent the wheel.
Note to children: Stone wheels don’t actually work, and Fred and Wilma were cartoon characters.
It was around 3,500 BC that the Sumerians first invented the modern wheel.
Stone blocks had been moved using logs as rollers but an axle to turn and rotate was a fundamentally new invention. It allowed the wheelbarrow to carry three times as much as you could carry on your back and a horse-drawn cart close to ten times.
A rotating axle spurred Archimedes to invent his water screw to lift water from wells. It led to the milling of grain between rotating stones pulled by a horse, ushering in the agricultural revolution. It changed everything in Europe and Asia.
What about the New World? The Aztecs and Mayans are famous for not inventing the wheel, yet still managed to create an empire. This is a bit of a myth because archaeologists have discovered Aztec toys with wheels. This meant they knew of axles and how they worked, but something didn’t work for them.
It turns out South America is a very mountainous region and wheels don’t work well on steep hills. And, North and South America never had strong enough pack animals to pull a cart.
Around 1,300, another genius (or just someone with a sore backside) put leather strips on wagon wheels to cushion the ride. Rubber padding replaced leather centuries later, but it tended to melt in the heat and crack in the cold.
Things changed when Charles Goodyear added sulphur to rubber in a process called vulcanization, after the Roman god Vulcan who was associated with sulpur and volcanoes. This kept the rubber pliable and strong across a much wider range of temperatures. The next step was the pneumatic tube, invented by a father who watched his boy painfully ride his bicycle on cobblestones. Adding air cushioned the bumps.
When the automobile era began, the tire industry was ready. Goodyear, Michelin, and Firestone led the way with tires that improved and strengthened each year as trucks got heavier and cars got faster.
Steel cords were added (“belted”). Radial tires lowered rolling resistance for better mileage and cornering.
At times, it looked like the tire was done. Trains don’t need rubber wheels. Airplanes have wings. But tracks can only go to flat places and planes still need tires. Trucks, and truck tires, are indispensable. In the great industry of transportation, you just can’t replace them.
Fast forward to today. The industry is exactly the same, and yet modernizing rapidly.
China has emerged as the new tire powerhouse with its massive internal market and relentless building of large industrial plants (often powered by coal). How did they catch up? They bought old tire molds and copied them. Quality is lower but the price is cheaper. They are getting better each year.
The biggest advance in transportation is the rise of electric vehicles. EVs have radically different engines, but they still need wheels. Just different wheels.
An electric car is much heavier than a gas-powered car. And they accelerate more quickly (more torque) from a standing start, so the synthetic rubber needs to be much stronger. EV tires wear out faster, too, due to the weight of these cars.
Michelin (France), Goodyear (US), Bridgestone (Japan) and several South Korean makers have been racing to create new tires built just for EVs (electric vehicles). So far, the race to supply Tesla seems to be led by Kumho and Hankook, the South Korean tire companies. Their plants are located closest to Tesla’s new factories in China, so they have an advantage.
CANADIAN TIRES
What about Canada? Synthetic rubber is made from the stuff we have a lot of – natural gas and oil – but we don’t have the refineries to make it. Michelin makes tires in Nova Scotia, but they have to be subsidized to stay open. Canada has just one company capable of producing synthetic rubber today.
The logical plan for Canada would have been to ship Alberta oil to our refineries in Ontario to make synthetic rubber ourselves, but distance and politics got in the way. Today, Alberta sells oil to the U.S. where it is refined. Then, we import all our synthetic rubber back from these same U.S. refineries.
Canada just can’t shake that “hewers of wood and drawers of water” label. We have the resources but don’t do enough with them.
WHAT’S IN STORE FOR ‘24
- U.S. technology companies have captured the world’s attention. They have the highest valuations and look like they will stay at the top forever.
They won’t. Other industries and companies will take the baton and lead the market. It may not happen right away, but trees don’t grow to the sky.
For example, for every Tesla sold, four tires are sold. And your Tesla doesn’t need to be replaced, but the tires do! Tesla trades at 75x this years’ earning – that’s expensive. Hankook, the leading Korean tire maker, trades at 6x earnings.
This is not a recommendation to buy a tire company, but rather an exercise in looking for opportunities in less obvious places. These are often industries we forget about. They are essential to modern society, aren’t going away, and have evolved with the times. We need them and yet we ignore them.
- There are many more opportunities outside North America, even though most people invest in what they know at home. You can’t easily buy Korean, Japanese, or European stocks, but they trade at much lower valuation than U.S. stocks. It is why we always recommend adding an international manager to portfolios to find these gems.
Despite all the troubles in the world today, we are extremely optimistic about the future. From new ways to think and create, to cheaper energy, to cures for disease.
Who could ask for more for Christmas?
From all of us at Dividend Value Partners, we wish you a very Merry Christmas and Happy New Year.
