TOP TEN HOLDINGS
The fourth quarter (and now into early 2016) saw continued volatility in global markets as commodity prices further weakened and investors exhibited concern about China’s slowing growth rate and monetary interventions by the People’s Bank of China (PBOC). The Fund took advantage of this volatility on both the acquisition and divestment front – please refer page 6 of this report for further details on specific names.
As we have written in the past, many investors fixate on the headlines on an almost daily basis and try to “time” the markets by buying and selling in rapid fashion. History shows time and time again that short-term events and headlines have very little impact on long-term business value in a meaningful way. We continue to exploit these short-term focused investors, as they enable truly long-term minded investors who focus on intrinsic value measurements to gain lower entry points and higher exit points in their selected investments.
During the periods of market strength in the fourth quarter we exited a number of positions – all of which delivered positive investment returns, including dividends, for the Fund over their respective holding periods: LAACO – Los Angeles Athletic Club which we held for 6.5 years and generated a return per annum of +13.2%, Molson Coors which we held for 4.7 years generated a return per annum of +29.8%, Imperial Brands plc which we held for 4.2 years and generated returns per annum of +22.8%, Post Holdings which we held for 2.2 years and generated returns per annum of +41.8% and EBay/Paypal which we held for 1.0 years for the spin-off transaction and generated a return per annum of +30.9%.
Please find a link to our newly created historical investments webpage, which records those investments we produced an investment presentation on so you can review our historical thinking on each of these investments. Here are two examples:
THE IMPORTANCE OF YOUR OWN RESEARCH
During 2015 the financial world has been trans-fixed with one stock in particular – Valeant Pharmaceuticals. (Note: we did not and do not hold this stock in the Fund or any of our client portfolios.) Valeant is a pharmaceutical company, which has been a serial acquirer of small pharmaceutical companies. Its key modus operandi is to cut research and development budgets immediately on acquisition and then raise prices of the existing drugs within the acquired companies portfolio. This is a very short precis of the issues (for those that are interested to learn more please visit here and here). The company had many high profile investors – one in particular Mr. Bill Ackman from Pershing Square Capital Management. Mr Ackman is an extremely successful investor and by virtue of this fact, many people follow his investments very carefully. In fact, it would not be uncommon to find numerous money managers that simply “mirror” Mr. Ackman’s and others portfolios with little or no due diligence of their own. Companies like Valeant Pharmaceuticals are frequently referred to as “hedge fund hotels” in the industry because they contain a large number of funds that have “followed” one or more large name investors.
This is not an “investment process” that occurs at Elevation Capital Management Limited. We undertake all of our own research and this is why we produce comprehensive presentations on the companies we own in the Value Fund (or on behalf of our Separate Account clients). Please find a link to presentations on some of our current investments here.
We have also produced our research into an Annual Research Publication – please find a link to our 2014 inaugural publication here. Our 2015 Research Annual will be released in late February 2016 and will be sent via an email link to all investors.
The Research Annual’s include all of our research presentations in a given calendar year irrespective of the returns they may have delivered. We believe this continues to set us apart from most fund managers (on a global basis) as we offer our investors a high level of transparency on where their money is invested (or has been invested).
The aforementioned research is a key part of the selection of enterprises we choose to invest in. Below is a snapshot of the companies we met with (or attended a presentation by corporate personnel) in the past year:
Our research process leads us to companies on our own terms. By virtue of this fact the Value Fund’s overall portfolio is quite unlike any other value manager that we are aware of and we continue to maintain a high “Active Share” versus the MSCI All Country World Index (“the Index”) equivalent to 97.2%. We have written previously about Active Share here. As a short re-cap, this means the Fund is 97.1% different to the Index and therefore only has 2.9% commonality with the underlying holdings of the Index. We believe this continues to highlight our independent thought process.
Our most recent research presentation is on Coach Inc. – a link to the presentation is detailed below:
Coach Inc. is famous for its Coach logo bags and accessories. The Coach brand is the #2 accessories brand worldwide. The Company has 965 directly operated stores, a presence in ~45 countries and 325 million customer visits per annum. The past expansion strategy under previous management led to excessive promotions that damaged the Coach brand and allowed competitors to secure meaningful market shares. Since 2013, the Company has embarked on a turnaround/rebranding effort - led by a new creative director Stuart Vevers. Investors are clearly becoming impatient as the Company continues to rein in promotions, close stores and execute a rebranding strategy, which has seen a significant decline in revenues and profits in the short term. This potentially provides a longer-term investment opportunity, as the stock now trades at multiples below that of its major peers and below past industry consolidation multiples. This is despite having a long list of positive attributes, such as a net cash position, real estate which can be monetised, strong free cash flow generation and a high dividend payout (with low risk to a dividend cut).
Lastly, Coach may potentially become an acquisition/merger target for a competitor, luxury conglomerate or even private equity.
Coach is currently (as at 31 January 2016) the largest position in the Fund with a weighting of 4.29% of the portfolio.
Portfolio Review – Q4 2015
a Global Monetary Experiment
As Jim Grant aptly wrote on 11 December 2015, “Ultra-low interest rates work their black magic as the clock ticks. They pull consumption forward in time and push failure backward in time. They flatter the judgment of aggressive lenders and ease the burdens of encumbered borrowers … The benefit’s of today’s monetary experiments are mainly in the past; the costs of those benefits loom mainly in the future.”
With Mr. Grant’s sentiments in mind we thought it worthwhile to highlight ...
UK households are once again spending more than they earn. Amongst developed countries according to the Wall Street Journal (WSJ), only Canada is now in a similar position. Higher home values are once again to blame and are fuelling a belief among homeowners they can bulk up on debt. History and current residential property price appreciation suggest to us this is a potentially growing risk for New Zealand. (Especially as we believe that New Zealand is becoming an increasingly expensive place to live relative to many developed countries around the world.)
Given our poor savings history this is clearly something to watch in New Zealand – especially as household debt is now returning to 2007 levels according to RBNZ data. The RBNZ Financial Stability Report (November 2015) tables that, “Household debt-to-income multiples (DTI) remain elevated at 160% of household disposable income, of which mortgage loans make up 84%.”
According to the RBNZ, “The price-to-income multiple of Auckland has now reached 9.2x, up significantly from 6.0x in 2011” – refer chart above. This is high by international standards and has seen New Zealand the feature of a recent report by Fitch (released January 2016) with the highest house prices in the world on a cost-to-income basis.
Additional commentary from the RBNZ concludes that, “substantial falls in Auckland rental yields in recent years are stretching the debt servicing capacity of investors, and suggest investors are entering the market on the expectation of capital gain. Consistent with low rental yields, the median Auckland Residential Property Investment Survey expects cumulative house price inflation of +48% over the next five years.”
It seems to us many people are falling victim to continued extrapolation of the immediate past with little or no regard to the underlying earning capability of the assets, the tenants earnings and fact the global monetary stimulus has seen a rising tide lift all ships in stable political jurisdictions.
Our caution may prove to be misplaced with regard certain asset classes (e.g. real estate) and the monetary experiment we now find ourselves immersed in globally. We freely admit we no longer understand the financial leverage within many parts of our economy and its affordability based on current income/earnings data.
Despite our caution, we remain positively constructed on the long-term outlook for our underlying investments – fractional interests in world class businesses / franchises. For example, despite slowing growth in China – we cannot escape the fact that they have the largest set of consumers in the world at present and their economy will be a lot larger in ten years than it is today. This is extremely positive for the likes of Coach, Kering, Remy Cointreau, Swatch, Tiffany and Tod’s – all holdings within the Value Fund portfolio at present.
So for the “market timers” in all of us, it is worth remembering that (excluding two commodity exposed investments – Chesapeake Energy and Anglo American) we are invested in enterprises that are well-capitalised, have a high percentage recurring purchases or desirable products with pricing power and most importantly are undervalued relative to what an experienced industry participant might pay to acquire the assets / brands of the business.
The Fund therefore remains an attractive vehicle to acquire fractional interests in world-class businesses / franchises at a sizeable discount to what they are intrinsically worth.