The Capital Cycle Podcast - Fish Tales

Episode Date: March 31, 2025

The attractions of the salmon farming industry.Edward Chancellor talks to Nick Longhurst.For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello, welcome to another episode of the Capital Cycle podcast. I'm Edward Chancellor, and I have with me Nick Longhurst, who's a European portfolio manager with Marathon Asset Management. And we're going to talk about fish. Marathon's last collection of global investment reviews, capital returns, contained a description of how the capital cycle operated in the cod fishing industry, from the late Middle Ages through to the 20th century. To recap, in the early 16th century,

cod was heavily fished by Portuguese fishermen off the coast of New England, Cape Cod and Iceland. Harbours' processing fish grew up along the North Atlantic coast, notably Boston, Massachusetts. This trade continued largely unchanged for centuries, but then by the 20th century, you had steam-powered trawlers with greater range, obviating the needs to dock in the American harbours.

And Clarence Birdseye, Captain Birdseye of TV adverts, improved freezing technologies that allowed the fish, the cod, be moved across the Atlantic in large numbers. And sonar resulted in more efficient location of fish shoals. Existing trawler operations had to invest heavily to keep up, becoming indebted in the process, and over-fishing became commonplace. Cod wars broke out as stocks depleted,

and governments asserted territorial fishing rights and started to subsidise their fishing fleets. And in the end, the consumers benefited, but deep-sea fishing became less profitable, and the old fishing ports went into decline. In the latest global investment review, the piece written by Nick talks about the fishing business,

but not from, fishing in the oceans, but fish farming and the fish we're dealing with is salmon rather than cod. Let's recap how you analyze the fish farm industry from a capital cycle perspective, and in particular how the fish business has moved from deep-sea trawling to farming and when that occurred. Well, in the salmon industry, the wild salmon volumes have remained pretty stable over time, and actually farmed salmon, overtook wild salmon in volume terms in, I think, 1999. So since then, it's been a one-way street with growth in the farmed market, while it stayed pretty static in the wild market.

And as you put in the piece, Marathon's capital cycle investment philosophy looks at how inflows and outflows of capital disrupt returns. Can you just elaborate a tiny bit on that? Yes, I mean, as regular listeners will know, Marathon's capital cycle philosophy is really predicated upon the idea that additional capital will seek to disrupt a high return industry if possible. Conversely, when industry returns are low, capital should logically look to exit or be forced to exit, which should then improve returns to the remaining player.

The opportunity set for Marathon is in the first of these situations, referred to as upper half of the capital cycle investments, is in finding businesses which can break this cycle and prevent additional capital from arriving to spoil the party. Not always as obvious as you might think. With our long-term holding period, averaging 10 years, if additional capital can find a way in to bring down returns, then it's likely to happen on our watch. So, Nick, you believe that the capital cycle has turned positive

for the European fish farm operators, as reflected by recent additions to Marathon's portfolio. Yes, two recent purchases for the European portfolio, bring an unusual additional barrier to entry for us to think about, which is that of sea temperature. Salmar and Baccafrost are two of the largest players in the salmon fishing industry. Salma is the second largest Norwegian producer as well as having operations in Iceland and Scotland, whilst Baccafrost is the largest play in the Danish-controlled Faroe Islands, as well as being the second producer in Scotland following an acquisition in 2019.

What are the natural barriers to entry in this industry? Well, sea temperature is a key barrier. salmon are fairly choosy about where they thrive. Whilst they can cope with sea temperatures of between zero and 20 degrees centigrade, they really like it best when sea temperatures only range between 6 and 12 degrees across the year. If it's too cold, they grow too slowly. When the sea heats up, this brings additional risk of disease and parasites such as sea lice, which can affect the health of the salmon, and hence the economics for the producers. This consistent range of sea temperatures is only really found in a few places.

The band across from Norway and Northern Scotland to Canada in the Northern Hemisphere and principally the coastal areas of Chile in the southern hemisphere. That means that Norway and Chile really dominate the market, with Norway accounting for just over half of the output, and Chile a further 25 to 30 percent depending on the year. In both countries, and indeed in most other markets, growth in output is controlled through a system of licences. Output in Norway, for example, is allowed to go up or obliged to be reduced.

area by area depending on a number of biological indicators. At various points in time, different regions have struggled with outbreaks of disease amongst the fish, which can lead to sizable drops in supply. The Chilean market has been particularly hit by this in the past. Regulation, coupled with the outbreak of biological problems in some years, has really kept a lid on supply increases, but particularly over the past decade or so. So the salmon farming industry was highly fragmented, but has consolidated in recent decades, driven in large measure by this colourful shipping tycoon called John Frederickson.

Can you tell me a bit about Frederickson's history and what he did to the industry? Well, as you say, he's a very colourful character growing up in Norway. I think he started work as a sort of shipping clerk when he left school, and then he had a photographic memory, so he was able to memorize shipping rates and charter rates in the way that others couldn't. And then over time, he eventually ended up owning ships, tankers, and I think he was very good at judging cycles, so he ended up making a good deal of money. I interspers here that the shipping industry is a classic capital cycle industry

and that it goes from boom to bust to boom to bust. And we talked about that in the capital returns book. But back to Fredrickson. What had happened through the 90s and then in the early 2000s, the banks had lent extensively into the sector. and there were lots of small companies heavily indebted and some larger ones. And when the industry went into one of its periodic downturns, they just found themselves with too much debt.

And what year was this? Well, through the early 2000s. And Panfish was the prime example. Banks ended up owning large chunks of it. And he saw an opportunity here. And he scooped up from D&B, the Norwegian bank, a 48% holding in Panfish. And then through that, was able to parlay this into owning the whole of that. and then plus merging with two other companies over the next few years,

fjured seafood and marine harvest. And once he'd done this, this company, which became eventually known as marine harvest, ended up with a 24% share of the Atlantic salmon market. And Fredericks himself left Norway, become a Cypriot citizen. Yes, he fell out with the government through a number of reasons and then relinquished his Norwegian citizenship and moved to London, but became a Cypriot citizen. And in London, he's known for having the second largest private garden after Buckingham Palace at his house in Chelsea.

So tell me then exactly the degree of industry consolidation driven by Fredericks. And then what happened since then? Yes, the company he controlled ended up with a 24% share of the Atlantic salmon market, as I said. And the top 10 producers were responsible for 67% of the output. In 1997, there were 70 producers responsible for 80% of Norwegian production, but by 2012, this is reduced to 22, so quite some degree of consolidation. And this has continued. I mean, more recently, Salmar, where we've recently initiated a position, has driven further consolidation through the acquisitions of NTS and NRS, having outbid Moe, which is the renamed Marine Harvest, which gives Salma a 20% share of the Norwegian salmon volume and a 10% global market share. So there's been a lot of changes in the market.

And what about the demand side of the equation? Well, while supply is relatively constrained, demand has continued to increase. I mean, salmon remains a niche product. It's only about 2 million tonnes of output per year. So it's really dwarfed by pork, poultry, beef and other farmed fish, even such as carp. However, the increased popularity of sushi and salmon's reputation as a healthy food has seen demand growth in previously unpenetrated markets such as the US. US salmon consumption per capita has doubled over the past 15 years and it's now the single largest

market, satisfied primarily by exports from Chile. Certainly if more salmon could be produced, it could easily be sold without affecting the price. Consequently, salmon prices have continued to remain very firm and certainly have been strong enough to allow the producers to offset the shortfalls in volume when these have occurred. In your piece, you publish a chart showing the annual changes in global supply of salmon, along with the price of European fish. After a rapid increase in supply around 2010, additions have been relatively muted in recent years and are set to stay at that level in the near future. Meanwhile, as you say, salmon prices remain robust.

And the supply, you also point out, is restricted by regulation. Yes, I mean, for the salmon farmers, the evolution. of the market from one of rapid but volatile supply growth to one in which supply is dictated more by regulation, that's actually been very beneficial for margins. And can you explain that, say for instance, for one of the companies you cite Bacca Frost? Yeah, well, for Bacca Frost, whose Faroe Islands salmon is considered to be the highest quality, also slightly higher weight, and therefore attracts a premium. At one point, this meant operating margins of 30% plus.

though these have actually come down a little bit following the acquisition of less profitable Scottish operations a few years back. Similarly, Sal Mar has been able to in recent years to consistently generate 20% plus margins, which is quite an uplift from the 10% level, which they were making in the early 2010s. So do you see any potential supply disruptions affecting the industry? I think, as I mentioned earlier, one always has to keep an eye on potential supply disruptions in this type of high return. industry. With salmon farming, the additional impetus has been the biological challenges that the industry has faced at times, which have thwarted the growth ambitions of some. Land-based farming in huge tanks was viewed as an answer to this and started to take off in earnest in 2016.

However, it's proved so far difficult to scale sufficiently to make an acceptable return. Since it can be done anywhere, although some methods used require a constant flow of water, hence necessitate being close to the coast. It's obviously not subject to the same production constraints as the licence-based system in the fjords. Similarly, some operators have experimented with offshore production further out in the sea in existing areas such as Norway, including Salmar themselves.

The remote nature makes this higher cost than there is the impact of rougher seas to deal with in terms of mortality of the fish. So far, both land-based and offshore supply threats remain relatively small at 1 to 2% of the market. So not much of the threat to worry about. about impact of government policy? Well, this has also been a disruptor in recent times.

In 2022, the Norwegian government announced that it planned to levy an additional resource tax on the salmon farmers, which prompted quite an extraordinary swoon in share prices across the sector. They sort of fell 30% in one day. The Faroe Islands also introduced modestly higher taxes. After a sort of period of consultation and a bit of a rethink, the Norwegians have subsequently rode back on the worst aspect of this. policy. And actually the opposition, who are ahead in the polls for the election at the moment,

have vowed to reduce it further. I mean, since the tax only applies to certain phases of the production process, you are able to mitigate it a bit through transfer pricing. Still, government actions are something that we have to think about. And I think one always has in one's mind that Fredericksson, you know, is still involved in the industry and he's not always the favorite person amongst some of the Norwegian politicians. So I'm not saying that was what prompted the action, but I'm sure it was in. the minds of some of them. A last word on valuations, why you find these stocks attractive? Well, as I said, there was a big drop in the share prices when the uncertainty area of the

resource tax hit the sector. And whilst valuations have recovered somewhat from the sell-off, they still look very attractive for an industry with this type of controlled supply and the ability to maintain premium prices as demand remains high and growing. Moreover, both Salma and Baccafrost have options from additional licences, which should allow them to outperform the broader market in terms of growth. So a combination of healthy pricing and some additional volume should lead to very respectable profit growth. Current cash flow yields for both companies are in the 5 to 6% range and this appears to mouth and be taking an overly pessimistic view of the value of our catch. That's very interesting Nick and I hope to speak to you

again soon. Thank you. Thank you for your time today. I hope you will listen to the next edition of the capital cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.