Charlie Munger on Country Risk and Twaddle of being a Capital Allocator

Reasoning behind the PetroChina investment?

PetroChina is not opaque. It’s very similar to big oil companies elsewhere in the world. It’s the 4th most profitable oil company in the world – it produces as much crude as Exxon. It’s not complicated – it’s a big integrated oil company, so it’s fairly easy to get your mind around the economics of the business.
The annual report will tell you more about the business than [the annual reports of] other oil giants. They tell you they’ll pay out 45% of their earnings, barring the unexpected. I like knowing that that cash will come to Berkshire.
It was bought because it was very, very cheap by any metric – far cheaper than Exxon, BP, Shell… You could say it should be cheaper, given that it’s 90% owned by the government of China, which is a factor, yes, but not so big for me. If you read the annual report of PetroChina, you’ll have as good an understanding of the company as reading the annual report any other oil company. Then, you can think about risks such as a disruption of US-China relations.

[CM: I think if it’s cheap enough, you can afford more country risk or regulatory risk. It’s not complicated.]

There’s Yukos, the big oil company in Russia. In evaluating country risk, you can reach your own judgments. In our view, PetroChina had less risk.

[Later in the meeting, Buffett and Munger returned to the discussion of this company:]

You don’t need any blinding insights to invest in PetroChina. They’re producing 2.5% of the world’s oil, it’s priced in US dollars, they control a significant part of the refining in China, and they pay out 45% of their earnings in dividends. If you’re buying something like that at 1/3 the valuation of comparable companies, it’s not hard. You just have to do the work.

[CM: But when you were buying, no-one else was. It required uncommon sense.]

We bought it a few years ago, investing $400 million. It was my first investment in a Chinese stock.

I read the annual report. They produce 3% of the world’s oil, about 80% as much as Exxon Mobil. Last year, it earned $12 billion in profit – only maybe five US companies earned as much last year.

The total market value when I bought it was around $35 billion, so I paid only three times last year’s earnings. The company does not have unusually large amounts of leverage and – this is unusual – has a stated policy of paying out 45% of its earnings in cash, so that’s a 15% cash yield [based on last year’s earnings, since Berkshire bought it at 3x those earnings].
The Chinese government owns 90% and we own 1.3%, so if we vote with them, together we control the business. (Laughter)

Unfortunately, we don’t own the same shares [as the Chinese government]. [We own another class of shares such that] we had to report our interest [in the company] at 1.3%. We would have liked to buy more, but the price jumped up [after our ownership stake was disclosed].
[CM: It would be nice if this [finding really cheap stocks] happened all the time. Unfortunately, it doesn’t.]

I simply read the annual report. I had no contact with management nor did I attend any management presentations. I just sat in my office and invested $400 million, which is worth $1.2 billion today.

I also looked at Yukos, the big Russian oil company [at the time I bought PetroChina] and compared the two at the time. PetroChina was far cheaper and I thought the economic climate was likely to be better in China. Yes, there was risk of tax laws or ownership rights changing, but the price was ridiculous.

Aren’t we doing a great job by investing in stock market and providing risk capital to entrepreneurs ?

CM: A bunch of bunkum and twaddle.

England had the best economic time in history when its stock market was closed for over 100 years.

(Agrees with my own philosophy that we are opportunistic wolves and primarily helping ourselves, notwithstanding with a few win-wins, but those win-wins would materialize regardless of a stock market.)

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India, the sole country worth investing in from BRICS at the moment. MNCs, however, even in India are not available less than 5 times revenues. Too bad.