Quarterly Review: Q4 (June) FY2018

Quarterly Review: Q4 (June) FY2018

What a quarter that was. The 10foot portfolio was flat until May, when it gained 6% in a week due to moves in Tower, NGE Capital, and a recovery in Just Group.

For a while I was up 12% since inception, double the index return – enjoying the warm glow that comes from being a Stock Market Genius – and then Oliver’s came along, and this and that happened, and I gave all that performance back and more. The portfolio ended the quarter at $10,773, compared to $10,000 at inception, trailing the index by 2.5%.

It’s 15 months since inception and I’m currently ~85% invested,  which I consider essentially fully invested. On balance I would prefer to have more cash, which may occur soon if I decide to sell Probiotec and NGE Capital.

Performance to date

The 10foot portfolio is up 7.7% since inception, trailing its XNT benchmark which is up 10.2% since inception.

The secondary benchmarks of XJO and XSO indices are up 5.1% and 19.3% since inception respectively.

10foot portfolio vs the XNT index.

And vs the XSO index:

10foot portfolio vs the XSO (ASX 300 excluding the ASX100) index.

Here’s a snapshot of the portfolio with cash holdings and current position sizes – as a percentage of current portfolio value, not as a percentage of capital that I allocated to each position:

via 10foot Google Sheets. Accurate as of 30 June 2018. “Undisclosed” positions are disclosed below.

The largest drivers of performance to date have been Probiotec and Tower.

I recently conducted a brief review of the portfolio from a risk perspective in May.

Average holding period? 

For many of my positions it is still early days. The longest stock I’ve held is Eureka, which I’ve held for 13 months, and Probiotec which has just passed the 1 year mark. There’s also NGE Capital (acquired in August), Just Group (September), Tower (November), Base Resources (March) and Oliver’s (May). I also have two undisclosed positions which I’ll disclose very briefly below, as I’m behind schedule in writing them up.

My average holding period by dollar value is probably around 8 months. While it would be nice to be beating the index, I’m happy with my progress so far and it’s likely too early to form any real judgement of my investing skill to date. (I promise I would have said that if I were beating the index too). After accounting for average cash balance, most of the performance detriment disappears.

One thing that is clear is that brokerage is killing me, as are some of the mistakes I’ve made. I’ll be switching to Interactive Brokers in the future due to lower brokerage and a wider range of markets to trade. I estimate it would cost around 1% of the portfolio to liquidate it at this point, so performance may be overstated.

I’ve also mentioned previously I’ll be increasing the portfolio size. That is still on the radar, but I need to convert my spreadsheet into a unit format, calculating performance per unit instead of just measuring performance by the gross $ value of the portfolio. (Otherwise when I add $10k to increase the size of portfolio, it looks like I’ve had +100% performance). I think I’ve said that for the last few quarters, but I keep pushing it back because I realise there are more things i’d like to add. When I convert to a unit basis I’d also like to add in pre- and post- brokerage figures as well as pre-tax and also a franking credit calculation. It’s a big project, will take a while.

Buy theses

FYI, I have purchased two new positions, Experience Co (ASX: EXP) and Greenlight Re (NASDAQ: GLRE). I haven’t published my writeups for them yet, as I’ve been working on some other stuff. My EXP writeup is almost complete but likely won’t be out until after the company publishes its annual report.

I have been struggling to articulate my theses on this blog. While I think the ideas and the work that has gone into them is (mostly) good, when I reread them I’m generally unhappy with their quality and I think that I miss the point in a few of my writeups.

One investor that I really admire for their buy theses is Capital H, from whom you can see a recent thesis on Livewire. Without commenting on the investment idea, the length of that thesis I think maybe a little intimidating – and I don’t mean that as criticism.

I’ve actively avoided writing buy theses of that length, but nor do I want to write a buzzfeed-style “This stock is going up becoz X, Y, Z.” What I’ve typically done so far is create a ~1500 word document that tries to summarise the main thesis as well as what I think are the relevant tipping points on which the investment will hinge. The end result however has usually wound up being some kind of bastard child that requires a large amount of implied knowledge on behalf of the reader – which the reader most likely lacks, because I haven’t been buying well known companies.

Capital H theses, while long, give the reader all of the information they need. Mine kind of say “hey here’s this info dump on XYZ, go and do the rest of the research yourself and get back to me,  btw stock’s undervalued.”

While I’ve tried to avoid the long theses, a hidden benefit of those is likely that people who are interested in the stock and have done the work (professionals) will be able to compare their own detailed assumptions against mine and say hey I think you’re right / wrong. At the moment I don’t disclose a lot of my research so there’s kind of not a lot in my theses to discuss or debate, if that makes sense.

Long story short, that’s why I haven’t published my Greenlight Re or my Experience Co theses yet. I’m trying to come up with a way to do them better.

Anyway, here’s an overview of how my stocks are performing to date:

Eureka Group Holdings – down ~20% since purchase

Unfortunately the new CEO, who I was optimistic about, has sadly retired and the Chairman has stepped in as interim CEO. To me that means greater uncertainty and more time before the company gets back on track.  Eureka is now trading at a 10% discount to net tangible assets of 30 cents (as at 30 Dec), but given the uncertainty I’m not in a rush to go and buy more. Given that I purchased slightly above book value, and the properties themselves are in rural areas without obvious property FOMO, I don’t see Eureka being a huge loser as long as debt is contained.

Eureka is a REIT-like business, so it earns $$ in direct proportion to the amount of capital it employs (so more debt is a ‘positive’ in this sense) but I would like to see the company’s overall debt levels lower. In my limited experience, problems with heavily indebted businesses rarely happen in good times: They happen when the market dislocates and risk appetite disappears – these being times when debt can’t be quickly refinanced or repaid via asset sales (because nobody is lending or buying). In other words, the downside of high debt – whenever it might arrive – is usually more sudden and vicious than one would expect based on historical experience of that company’s borrowing behaviour or even a static look at the company’s financial position.

I think it’s possible Eureka’s discount to NTA could increase, depending on what the annual results look like. I’ll be looking closely at the annual report, although the company has a decent set of strategic plans in place and these should be able to continue to be executed while the company seeks out a new CEO.

Probiotec Limited – up ~220% since purchase

Probiotec worked out a whole lot quicker and more explosively than I expected, & I have no complaints.

I’m in a holding pattern with this position at the moment. It’s starting to look fully valued at $1.25 recently, although insiders continue to buy more and I’m still waiting to see whatever this ‘opportunity’ is that management is talking about. I tell myself patience is a virtue. I have a mind to selling once the thesis is fully played out, which may be after the full year results.

NGE Capital – up ~50% since purchase

I wrote when I purchased NGE that I would a) look to benefit from the underlying investments and b) try benefit from a closure of the discount to NTA. Given that both have now largely happened, I need to consider whether to consider holding or selling. I’m a bit iffy about owning investment managers in the 10foot portfolio (as it’s supposed to be about improving my own investing process) so we’ll see.

The thesis has played out quicker than I expected, with Godfrey’s and Mineral Deposits receiving takeover bids and PowerWrap moving closer to IPO following the recent funding round. NGE has now largely closed its discount to NTA, and several of its investments appear to be in the late stages of their investment thesis. Post-takeovers, NGE will have a lot of cash on hand and perhaps not too many places to deploy it, although their NTA composition (increasing % of equities & cash) suggests they continue to find ideas.

I am aware that my original NGE thesis is nearly fulfilled and will be keeping an open mind about what comes next. At the moment I am leaning towards holding, but I need to see what the company invests in next before making a decision.

On a separate note, I’ve been thinking that takeover bids for positions make it harder to evaluate manager skill, as the investor doesn’t get a chance to see the actual business thesis play out.

A second possibility is that NGE’s skill comes at least partly by selecting investments that are strategic/ likely to be bought out. NGE is run almost entirely by ex-Bain and ex-Credit Suisse staff, and I have always operated on the assumption that NGE is more “deal savvy” (i.e., ‘find something that someone else will want to buy’) than some other funds out there. Given the number of takeover bids for NGE positions so far, this would seem possible.

That’s speculation, and it is contrary to what is said in this interview with David Lamm. Higher deal activity may simply reflect greater M&A activity and lower cost of debt at this point of the cycle. In hindsight, in that interview I should have spent a lot more time digging into the exact mechanics via which NGE intends to generate outperformance – the exact type of trades they like to place, situations in which they think they can tilt the playing field to their advantage. Perhaps in a year I will approach NGE for a follow up interview.

Finally, I’ve been thinking about Powerwrap and its market, and I think that this will likely be a winner-take-most market. I’m not sure if Powerwrap will be that winner. I’d be keen to see NGE get out of Powerwrap fairly soon, but that is a story for another time. In a very quick summary I think likely that assets will accrue to the best and lowest cost provider (rush to the bottom on price), which will take most of the market. Competition is certainly heating up.

Just Group plc

I was concerned to see that Just Group’s private equity shareholder Permira sold out the remainder of its stake (18% of the company) at 143 pence; a significant discount to NTA of 165p. Permira made a decent amount of money in Just, and it’s been 9 years since they took Just private and 6 years since they re-floated it, so it’s certainly time for them to move on. Even so, I’m uncomfortable to see them selling out substantially below what would seem the obvious measure of fair value – the book value. Permira’s exit has been well telegraphed with a previous sale of 5% of the company a few months ago; perhaps the market was unwilling to close to the gap to book value in anticipation of Permira’s sale. There are virtually zero Just shares short sold at the moment, other than a 0.5% short position from Odey Asset Management.

It’s possible or even likely that Permira was aware of the likelihood of higher capital requirements (more on this below) and elected to sell at a discount to NTA rather than risk waiting another couple of years for the discount to narrow.

From a business perspective, early performance so far this year has been encouraging with a recent positive business update. I increased my position in Just at 139p after that update, and am looking slightly foolish (and feeling moderately robbed) given the decline in the share price since then.

I think over time Just Group can grow at a decent rate as well as converge towards book value (I would argue it could be worth more than its NTA), and I’m happy to continue holding. Just released its annual report in March, so the next report won’t be until September.

I recently wrote here about some changes to Solvency II which could impact Just Group’s solvency position and may have an impact on the way Just is being priced by the market.

Subsequent to the end of quarter, Just released a business update acknowledging the possibility of higher capital requirements (the Solvency II changes I wrote about) and this has had a serious impact on the share price, 60% growth in new business sales notwithstanding. Just shares are down ~20% since the end of quarter. It is my view that the potential impact is likely overdone, which I may write about in the future. 

Tower Limited

Tower’s half year results came out and they were mixed. The core numbers of policyholders, GWP, % of new business sales online, and cost ratio moved in the right direction, although the company continues to struggle with even small disasters continuing to deliver a meaningful hit to the bottom line via claims expenses.

The IT systems upgrade will cost substantially more than I previously expected, although the expected returns on the reinvested capital are still around 20% if the upgrade is successful – hard to argue with. Canterbury claims ticked up mildly and the IBNR coverage ratio fell from 99% to 89%, somewhat concerning as I’d hoped those were finally swept under the rug. If Tower continues to lose money on its core business due to adverse advents (e.g. earthquakes), then it will likely require additional capital, especially if Canterbury claims are still growing.

With address-based pricing coming on in ~18 months or so with the new IT system, and open Canterbury claims seeming to decline at around 20% per half, the risk of this should be declining. The next 2 years or so will be very important to Tower from a capital perspective.

One thing I found curious was the 10% increase in policy pricing, given that Tower’s main thrust of business is that by using address-based pricing in the future it can price itself out of earthquake areas and charge lower prices to insure city-dwellers, thus competing on price and taking market share from the majors. It’s an intuitively sensible strategy which an increase in policy prices in the half seems to belie. Tower mentioned it implemented ‘risk based pricing’ in the half so this 10% increase may be due to that. Tower has historically admitted not repricing many of its policies for “years” so I am not too concerned about this.

I have been politely asking (and more recently, hassling) Tower for months to get an interview with the CEO or at least to get the IR to answer some questions for publication on my blog, similar to what I did with NGE.  My efforts have been unsuccessful and I may elect to post the questions unanswered. I think this company has several key governance issues.

Base Resources

I have just purchased Base Resources. I received an interesting comment on the linked post which is worth considering.

The comment disagreed with my statement that Base is essentially an ilmenite miner and that the rutile and zircon just increase the economic viability of the ilmenite. This may be a semantic debate as the ilmenite/rutile/zircon coexist, but I asked myself would Kwale (Base’s current mine) or especially Ranobe (the new mine) be viable as a standalone rutile or zircon mine?

The answer is ‘absolutely not’ for zircon, ‘maybe’ for rutile at Kwale, and ‘probably not’ for rutile at Ranobe. Thus it is my view, and I think I am correct to say this, that demand for titanium pigment and ilmenite is the most important thing to pay attention to over the next 5-10 years, especially once Kwale closes down. Base is also fortunately in a position where it benefits from chloride ilmenite demand (via having both rutile and relatively clean sulphate ilmenite that can be upgraded), and as a result I’m not too concerned about the general switch towards chloride processing.

I still think this is important to keep in mind if ilmenite prices ever decouple from the more valuable rutile and zircon prices. Historically they have hewed closely to each other but you can see in this chart that there can be variance:

BSE presentation, Sep 2017

I am not forecasting such a decoupling, but if ilmenite is truly the primary driver of these mines then I think this is prudent to keep in mind. One interesting element of that chart is that ilmenite prices have been rising faster than rutile over the past few years, which could indicate the market is tightening.

Ilmenite prices are currently around US$170 and Rutile is around US$1000/tonne, so you can see we are a fair way from the top of the cycle prices. I have not forecast this for my model, but I am optimistic that pricing continues to improve due to tight supply.

Elsewhere, the titanium pigment manufacturers are consolidating which usually bodes well for industry ROIC. There’s an interesting thesis there for Tronox (as a pure TiO2 play) or Chemours (multi-business conglomerate) which I may write about in the future if I find something useful to say.

Oliver’s Real Foods – down ~50%

I have made some poor decisions since starting this blog, but this is the first genuinely stupid one that I’ve made – and it’s been an irritating, albeit deserved, lesson in market timing. I wrote when I sold Oliver’s the first time that Oliver’s should Abandon the full year guidance, I doubt that it will be met anyway, and consider really focusing on the operations of the business to build a good culture moving forwards.”  

I didn’t know for certain there’d be a downgrade, but I thought there was a decent chance that there was one coming down the pike. I sold for a variety of reasons, then the founder resigned and a new CEO stepped in, and I visited an Oliver’s store and noted several improvements that didn’t exist the last time I was looking. This suggested that the company was more open to change than I previously thought, and also that there were still low hanging fruit that could generate a meaningful uplift in results.

I thought there would be an opportunity to strike while the iron was hot and get some suggestions in front of management while the window of change was open. That inspired my recent presentation to Oliver’s.

Over a 5 year view I thought (and still think) the company is undervalued and has the potential to make it work, so I bought OLI shares again. Conversely, I could have waited a few weeks and purchased 3x as many Oliver’s shares for the same money.  The problem was that I didn’t sit back and think any of a variety of thoughts that would have made me more patient. On balance, at any corporation, what are the chances that a new CEO decides to ‘clear the decks’? Probably like 80%-90%?  It was nearly guaranteed that there would be some kind of write down or change of strategy – in fact I and possibly others were actively advocating for changes to some parts of the strategy. So that showed a distinct lack of awareness on my part.

As a private investor I’m a bit less sensitive to price – My perfect investment would be buying shares at 70, buying more at 60 and then loading the boat at 40 when I think the company is worth 120+ (assuming I’m right about the business),  but as a public investor (I only invest my personal $$, but I publish all my decisions) tracking performance quarterly,  I really should have had better execution here.

I know to some extent I also wanted to have skin in the game when I made my presentation to Oliver’s. One of my deepest core beliefs is that you should not criticise a problem unless you personally can do it better and/or are willing to fix it yourself. That standard is nearly impossible to meet in investing – very few investors (including me) can actually do the things that they think management should do operationally – but still, if I’m going to publicly tell a company what to do with its strategy, I am morally obliged to contribute to solving the problem via either providing capital (owning shares) or hard work (my presentation).

Due to these factors, on some level I wanted to have $$ in Oliver’s shares when I published my presentation. While I do think the company is potentially worth more than 28 cents, this was still an emotional/morality-driven decision and therefore a mistake, one that I hopefully won’t make again. Oliver’s cost me 2.5% of performance in this quarter.

It’s a lesson that even when you are trying to invest on fundamentals over multi-years, it doesn’t pay to ignore short term noise. Sometimes the right decision is to step back from the market and let the changes wash out (I knew that, and I bought shares anyway… you can’t help some people). I hope that I’ve learned my lesson.

Business-wise, I think there is a good case to be made for a turnaround, which I wrote about here.

On the plus side, Oliver’s appears to have already implemented a couple of the suggestions that I made in my recent presentation, and hopefully the rest are on their way. In my presentation I thought Oliver’s needed to:

  • Address customer bottlenecks in stores (OLI is installing customer ordering Kiosks)
  • Lift social media quality  (OLI Facebook is already wayyy better)
  • Focus on cross-selling and upselling customers
  • Drive foot traffic
  • Consider, in time, a formal store layout/ plan for more efficient service
  • Make sure the supply chain is correct


Oliver’s is also going to have, within a year, a technology system that records all store metrics in real time. I think this is really going to give the company immediate and visceral feedback on what is or isn’t working. Depending on what exactly the system does, I can think of a large number of potential opportunities from its implementation.

While these things are not immediately valuable (in terms of intrinsic value), I think they will really give the company the tools it needs to improve, and I’m optimistic about OLI from here.

Greenlight Re

I have purchased shares in David Einhorn’s publicly listed insurer/hedge fund vehicle. It was ~30% net long the US market at the time of purchase, with large positions in Bayer, General Motors, Mylan, and Brighthouse Financial (among others) and short positions in Amazon, Tesla, Netflix, as well as a collection of “bubble” stocks. Performance has been shockingly bad in recent times and Einhorn is being vilified in the press. I think he’s much better than his recent performance indicates and I think he’s also fundamentally right about some stocks like Tesla and Netflix – but he’s shorting a market that is rabidly buying anything that is delivering revenue growth.

Companies like Amazon, Tesla, and Netflix are being valued on multiples of revenue and their future potential. While they have great products and may even have great businesses (AMZN), these three stocks are likely to be hit much harder than the other FAANGs (FAANGTs?) in the event the market switches to focus on financial security/ cash flow/ profits – as it always does in a downturn.

Still, GLRE is obviously getting its face ripped off by being short US bubble stocks, and it is an interesting, and uncomfortable, contrarian bet.

GLRE benefits from insurer leverage, a 20% discount to NTA, and is a cheap bet on a market downturn as well as a bet on a solid yet out-of-favour manager. Greenlight is likely to lose money in the near term until the cycle turns. As the boom turns to bust, I think GLRE will make decent money fairly  quickly in the downturn, and following this it could choose to become an aggressive buyer of stocks, which would be an interesting approach at the bottom of the cycle when equities are cheap.

There is regulatory risk regarding the continuance of the insurer status, as well as the profitability of the insurance unit. GLRE’s management fee is typically 1.5% of assets p.a. and 20% of performance. I have a gripe with the GLRE performance fee given that there is no benchmark and only a partial high water mark. On the plus side, performance fees have been halved to 10% of performance “until all the losses are recouped and an additional amount equal to 150% of the aggregate investment loss is earned” which will take a very long time to recoup.

I made GLRE a ~5% position at ~US$15.50 in April, and the share price is down 9% to ~$14.10 since then (as of end of quarter 31 June 2017).

Experience Co

I think this is a well-run business with a decent set of opportunities that can grow substantially from here. I made EXP a ~9% position at ~$0.58 in May, and it was up ~10% at the end of quarter. I have almost completed a lengthy presentation on it, which I will likely publish after I can update it for EXP’s full year results.

I own shares in Eureka Group, Probiotec, NGE Capital, Tower Limited, Just Group, Base Resources, Greenlight Re, and Experience Co. This is a disclosure and not a recommendation.

Comments: 4

  1. Avatar Ollie says:

    I am also of the view that this is a rutile mine.

    Base Resources product sales for the quarter were as followings: 9,007 tonnes of zircon, 107,170 tonnes of ilmenite, 25,635 tonnes of rutile

    Based on these sales volumes, I’ve calculated the % contribution to revenue from each product using the following pricing assumptions (zircon price ~ $1200/tonne, ilmenite ~ $180/tonne, rutile ~ $906/tonne).
    Ilmenite: 34%
    Zircon: 22%
    Rutile: 45%

    This will be even more evident next quarter when:
    (1) Zircon prices increase (> 10%) in line with Iluka’s benchmark price;
    (2) Rutile prices increase (~ 14%) in line with Iluka’s benchmark price.

    Using the updated pricing assumptions for next quarter (zircon price ~ $1400/tonne, ilmenite ~ $180/tonne, rutile ~ $1,000/tonne), revenue contributions will be as follows:
    Ilmenite: 36%
    Zircon: 20%
    Rutile: 44%

    • You make a good point Ollie. It is kind of a pointless comment to make from me I guess – just being picky.

      When I value Base over a 5-7 year period (combining Kwale and Ranobe, and using conservative price assumptions), it really looks to me like the ilmenite is more important. I could be wrong – and since this is supposed to be a shorter term profit from a re-rating maybe I actually should be more focused on the rutile price. Thanks for pointing that out.

      Do you have a view on where zircon/ilmenite/rutile prices go over the next 3-5 years?

  2. Avatar Nick Wilkesmann says:

    Very interesting write up. thanks

  3. Avatar Chris says:

    One thing I find useful to look at is product review.com.au. I looked at the reviews on Oliver’s and they were shite so stayed away. Appreciate that people will write negative reviews quicker than a positive one but hardly saw a positive one. I can visit one or two stores to see how things are but could be deceptive if these are a couple of their better ones.

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