Quarterly Review: Q2 (December) FY 2019

Quarterly Review: Q2 (December) FY 2019

It’s been a while since my last quarterly report, and in fact I was late recording the data for this one – but what’s a 99 day quarter between friends. The 10foot portfolio is down 4% since inception at 30 March 2017.  This compares to its main comparison index, the XNT, which is up 5% since the same time, resulting in total underperformance of 9%.

Google Sheets has again changed the way it formats charts, so for reasons known only to the great gremlin in the sky I can’t convince it to shorten the Y axis. The G Suite is a great group of products but I find it tends to get harder to use with updates, rather than easier.

Anyway, the 10foot portfolio (yellow line) vs secondary indices of XJO and XSO is down 1.8% and down 4.5% respectively since inception.

Relocation

I sold my position in Eureka Group (ASX:EGH) as well as a quarter of my Tower Limited (ASX:TWR) and most of my Base Resources (ASX:BSE) position. I recently relocated to Sydney and have kept additional cash on hand in the portfolio in case of unforeseenities (you will note the high cash % in the portfolio below).

I have missed several good opportunities to buy stocks I wanted to own but was unable to purchase due to a foreseeable need for cash.  I managed one purchase – I purchased more shares of Oliver’s Real Food (ASX:OLI) at 9 cents just before Christmas.

Before I get into a discussion of current positions:

Upgrading 10foot

I have thoroughly enjoyed tracking the 10foot portfolio and it has done wonders for my investing skills.  As a result my intention is to bring my whole portfolio onto this blog. I currently intend to treat pre-existing positions as if they were purchased at today’s prices (rather, the price of whenever I move them into my spreadsheet) so as not to claim any benefit from purchases that I haven’t detailed on this blog. I will also be switching the 10foot portfolio to a “unit” basis, so I will track the value of the units per time, rather than the dollar value of the portfolio. I have talked about this for a while but I will get around to it soon (honest).

Long story short, you can see the full list of my current holdings below, although there are now only three stocks that are not in the 10foot portfolio.

Here is a list of current 10foot positions and cash holdings:

Here is the performance of these positions since I purchased them:

Here are my latest thoughts on each of these positions:

NGE Capital

NGE itself continues to hold EGH (which I’ve sold) and BSE. Im generally optimistic on both of these companies, but the elephant in the room is NGE’s ~20% position in Russian oligarch company Rusal. There appears to have been some political progress towards getting sanctions lifted on that front, which has been good and shares are up sharply on NGE’s purchase price.  NGE has also taken a 20% position in an LSE-listed yellowcake uranium holding vehicle.

The overall result of this is that NGE has (I guesstimate) 45%+ of its assets in aluminium, uranium, ilmenite, and coal companies. One positive of these is the non-AUD currency exposure, although as with BSE below, the risk is that NGE is buying “cheap” commodity companies at a cyclical peak.

I think NGE has an established investment process that is working for it and I continue to hold. I do have some theories about its idea generation process that I want to look into a bit closer. With a little luck, CIO David Lamm might be willing to reappear for another interview on the blog.

Just Group plc

Just Group.  In my view the company was a buy at 72p in Sept 2018, and at that time buyers were explicitly being compensated for the uncertainty caused by proposed regulation. The company had just cut its dividend to retain capital while proposed higher capital requirements were uncertain. It looked risky but on balance it seemed likely that the UK regulator would allow a transitional period for any new capital requirements (because the alternative was that DB pension insurers could all need to raise new capital at the same time).

I made a specific decision not to buy at 72p because I already had a substantial stake in Just (it’s a 15% position in terms of capital invested) and I am mindful of the risk of doubling down on leveraged business models in a time of uncertainty. As a shareholder I also had the implicit option of waiting for the higher capital requirements to be implemented, and then participating in any capital raising.

The regulator has subsequently confirmed that it will allow a transition period, which resulted in Just Group trading up to between 90-100p recently. The PRA release is here and it looks mild. I still think Just Group is undervalued, and given the transition period confirmation and management’s decision to seek permission to issue convertible bonds to shore up the capital position (which likely means no capital raising), I would be willing to buy shares again at today’s prices. I have made no trades in Just and likely won’t for the foreseeable future as some other holdings (EXP and OLI), as well as some international stocks, look more attractive.

I’m still not sure if I made the most optimal decision, especially given that I just wrote that I avoided Just at 72p but now would buy at ~90p, but I think that on balance, given my existing holdings, I was sensible to wait.

I have previously summarised the bear case for Just Group here. With Just Group moving to put higher capital requirements behind it, the major risks now are its corporate bond portfolio, and UK house prices.

Tower Limited:

Tower continues to progress well with its expense ratio and new policy growth both moving in the right direction as of the recent annual report. When you get GWP growing at a couple of percent per annum and costs falling at a couple of percent per annum, good things can happen – assuming good underwriting.  Operating costs and claim costs have always been an issue for Tower (it is sub-scale, in my opinion) but with operating costs moving to a more reasonable level, the focus on its underwriting ability will be heightened. I think that Tower will figure this out, although management’s continuing decision to claim earthquakes and disasters as “one-offs” is a black mark against them (insuring against “unusual items” is literally the reason the company exists).

On the plus side, industry pricing appears to be increasing and Tower’s risk selection process should also be improving due to some internal developments, so I would expect to see a stronger result this year.

Tower’s annual report was a bit cookie-cutter. Have a look and count how many times it says “already implemented or in train to improve results in the coming year.”  I decided to sell a few shares on these concerns, but I remain optimistic on Tower and it is one of my larger positions.

Base Resources:

Ilmenite prices have recently experienced a slight downturn amid all the China trade war drama. When I purchased Base I assessed that ilmenite prices were approximately mid-cycle and slightly below or in line with the 30 year historical growth rate of ilmenite pricing. I also assessed that supply was probably tightening and that Base’s new mine will be quite attractive.

A lot of that will be invalidated if the Chinese either a) stop making titanium (unlikely) or b) experience some kind of upset such as a housing market/homebuilder collapse, corporate bankruptcies or what have you that will indirectly disrupt the titanium pigment market (plausible).

The other possibility is that Base is a classic top of cycle purchase – a mining company on 3x earnings at a cyclical peak.

There is a possible distal benefit to come from the consolidation of titanium manufacturers Cristal and Tronox in the USA. This may or may not proceed because the Feds suspect it will reduce competition and increase titanium pricing (which it will). From what I have read, the US has a mediocre record of preventing industry consolidation and improving pricing power, so I would be surprised if this merger is blocked. Industry consolidation could also conceivably put pricing pressure on Base, but probably not if titanium supply is tight. Base sells most of its ilmenite into China, so this merger is likely not an immediate driver, but it is relevant.  In any event Base is a 2.5% position so I am happy to continue holding.

Oliver’s Real Foods:

I’ve purchased more shares in Oliver’s on two occasions in the past 6 months or so, both at 9 cents. Broadly speaking I think the new CEO is competent and has a good grasp of the business. As I’ve noted in previous presentations, there are a large number of ‘low hanging fruit’ improvements available in the business and, unlike more equivocal initiatives at mature businesses that are riskier and have more uncertain outcomes (e.g. Domino’s adding milkshakes), Oliver’s improvements are highly likely to improve customer satisfaction and spend per transaction, which is vital. Olivers’ is also one of the highest margin eateries in Australia, which I think probably has to change, but if it can scale up and grow same store sales organically, it can conceivably do quite well.

Management’s recent forecasts make the business look expensive today but I think this is a conservative estimate (which I like) and I think Oliver’s has scope to exceed expectations.

Greenlight Re:

I was too smart by half buying Greenlight Re – so smart I was dumb.  At the time of purchase I bought it for $15/share with an NTA of $23/share and a break-even insurance business.  Under a year later it has a share price of $9 and NTA of ~$14(?), having had the worst year of investment performance I believe in its entire history – down 30%.  The insurer/fund is now of a size, in my opinion, where being wound up is well within the realms of possibility. In the unlisted main fund (not GLRE), FUM is racing out the door.

While I think Einhorn has still “got it” and his core positions at least make sense to me analytically, the portfolio continues to struggle with shorts going up and longs going down. I think the core of Greenlight’s problem is being short unprofitable tech co’s that the market is very keen on at the moment. Having large short positions that move sharply make it hard to stay in the game given the ongoing cost of holding these (a problem which long investors do not face).

When I originally purchased GLRE units I probably underestimated a) the scale of losses yet to come from this strategy and b) maybe overestimated the speed with which some of Greenlight’s short positions would start to work out.  If you’d asked me to forecast Greenlight’s performance at my time of purchase (May 2018) I would have said “NTA decline of 10-15% this year, 1-2 years before the market narrative on tech stocks starts to change” (which itself was an error of false precision). Ironically there has recently been a little selloff in many highly priced companies, yet Greenlight’s results continue to struggle.

I also assumed (and continue to assume) that Tesla and co will be the bellwether for a dramatic market re-think about the viability and plausible future growth prospects of many highly priced businesses in tech (and “tech”) and elsewhere.

We’re only about 7 months into those two years I estimated, but the scale of losses so far shows that I was probably projecting my own views onto the Greenlight investment case too strongly. Market rationality, your solvency etc etc, which is particularly important for an insurer with open short positions. Mea culpa.

Experience Co:

I don’t have much to add on Experience Co at this point. I think it is quite undervalued at 30 cents although a key concern is that management doesn’t oversupply the market/ intensify competition too much in their attempt to grow earnings and market share.

I recently spoke with an analyst covering Experience Co who pointed out that Cairns airline traffic has been declining recently (a data point which I was not tracking – I’d been tracking tourist numbers YoY). One plausible theory is that Experience Co downgrades again and gets hammered, in which case it is not inconceivable that it trades substantially below 20 cents.

I was sent a recent post on website HotCopper claiming that EXP lost a major contract with Quicksilver for providing helicopter services. That’s obviously not ideal but I’m also not surprised to see it go – as noted previously, Quicksilver is EXP’s biggest competitor in Cairns. A bigger concern is if the contract loss presages competition heating up.

At the right price I would likely be an aggressive buyer of EXP as I believe that these businesses have enduring earning power and a reasonably friendly industry structure (oligopoly), but things can change.

My other positions

These are not included in the above portfolio performance, although in the future they will be. I’ll let you know when that happens.  I own:

Xero (ASX:XRO) – large position

Nearmap (ASX:NEA) – large position

Despegar (NYSE:DESP) – tiny position. More on this position in the footnotes to this post here.

Oliver’s – I already hold Oliver’s but I made a second OLI purchase in the past year that was not included in the 10foot portfolio. When this comes into the portfolio it will change the weighting to Oliver’s.  Just FYI.

That’s about it I think. As I mentioned previously I’d be glad to hear more from anybody that knows something about Despegar, which I’ve spent a fair bit of time on recently.

I own shares in NGE Capital, Tower Limited, Just Group plc, Base Resources, Oliver’s Real Food, Greenlight Re, Experience Co, Xero, Nearmap, and Despegar. I have no intention of making any trades in these stocks for the next 7 days.  This is a disclosure and not a recommendation.