MOI Global | The Membership Community of Intelligent Investors

LDC: Dominant French Poultry Producer With Clean Financial Record

October 8, 2022 in Audio, Discover Great Ideas Podcast, Equities, Europe, European Investing Summit 2022, European Investing Summit 2022 Featured, Ideas, Member Podcasts

Jeremie Couix of HC Capital Advisors presented his in-depth investment thesis on Societe LDC (France: LOUP) at European Investing Summit 2022.

Listen to this session:

slide presentation audio recording

About the instructor:

Jeremie Couix is a co-founder and managing director of HC Capital Advisors based in Germany. Prior to co-founding HC Capital, he worked at Discover Capital as an investment analyst and later as co-portfolio advisor of the fund Squad Growth. Previously, he worked at FORUM Family Office, a value-oriented investment manager based in Munich. Jeremie graduated from EM Lyon Business School in France with an MSc in Management.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated herein.

Ferguson: High-Quality Distributor With Improving Business Mix

October 8, 2022 in Audio, Discover Great Ideas Podcast, Equities, Europe, European Investing Summit 2022, European Investing Summit 2022 Featured, Ideas, Member Podcasts

Adam Crocker of Logbook Investments presented his in-depth investment thesis on Ferguson (UK: FERG, US: FERG) at European Investing Summit 2022.

Listen to this session:

slide presentation audio recording

About the instructor:

Adam Crocker, CFA is Founder and Chief Investment Officer of Logbook Investments, a value fund with core positions based on insights from books. Logbook launched in 2016 and is seeded by his former employer. Prior to Logbook, Adam was a co-manager at Metropolitan Capital Advisors, a long/short equity fund founded in 1992. Before joining Metropolitan, he was an analyst at Morgan Stanley Investment Management conducting research on behalf of growth and value investment teams. He began his career in Leveraged Finance investment banking at JPMorgan. Adam is a 2005 graduate of the Value Investing Program at Columbia Business School and has an undergraduate degree in Economics from Columbia University.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated herein.

Ceconomy: Owner of Europe’s Top Consumer Electronics Retail Brands

October 7, 2022 in Audio, Equities, Europe, European Investing Summit 2022, Ideas

Markus Matuszek of M17 Capital Management presented his investment thesis on Ceconomy (Germany: CEC) at European Investing Summit 2022.

Thesis summary:

Ceconomy, Europe’s leading consumer electronics retailer (brands: MediaMarkt, Saturn), is resolving several challenges: (a) a shift away from its bricks-and-mortar business towards online, fueled by the COVID-19 pandemic; (b) a simplification of its governance structure as a consequence of settling a dispute with the MediaMarkt founder family; (c) a multilayered transformation aiming at new store formats, a ramp-up in logistics and strengthening its competitiveness towards an enhanced omnichannel business concept; and (d) achieving sustainable cost savings of over EUR 100 million per year (+29% of normalized EPS).

Ceconomy shares recently traded at 2.4x normalized EPS with a dividend yield of 14%, not considering its equally depressed minority investments which represent almost 50% of the market capitalization.  Given the company’s ample and unused debt facilities, Ceconomy is well-positioned to benefit from the expected cyclical upswing post the soft consumer climate, while providing significant downside protection.

Listen to this session (we apologize for the audio quality issues):

slide presentation audio recording

About the instructor:

Markus Matuszek is an investor and entrepreneur. He is the founder, CEO and Chief Investment Officer of M17 Capital Management, who invests into long/short value positions as well as private opportunities, biased towards European ideas. His group also acquires ownership positions in companies and seeks to maximise their long-term potential by working with management and other shareholders. It invests its own capital and works with a select group of co-investors. Markus aims for controlling positions yet is flexible in holding periods and transaction structures. His focus is to invest in stable companies which are undergoing change and he does not shy away from distressed situations or structural dislocations, provided the risks are acceptable and he believes in a company’s long-term value creation potential.

Prior to M17, Markus ran asset management and advisory firm Hermes Capital Management as well as he was a managing partner at hedge fund Gabelli & Partners. He has been investing in listed securities, private companies and real estate over 20 years with a solid track record. Earlier in his career, Markus was a senior advisor / interim manager with extensive advisory and hands-on work in strategy, restructuring, organizational change, corporate finance/M&A and risk management in Western Europe, Eastern Europe and the US. He started his professional career with McKinsey & Company. His education includes a M.A. in finance, accounting and controlling from the University of St. Gallen (Switzerland), a master degree from CEMS and dual MBAs from Columbia Business School and London Business School (with honors). Furthermore, he studied at the Warsaw School of Economics and University of Geneva and received several merit-based fellows and scholarships. He is also a CFA charterholder and a long-term jury member for the CFA Institute’s Research Challenge in Switzerland as well as for EMEA.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated herein.

Larry Pitkowsky on the Investment Philosophy of GoodHaven

October 7, 2022 in Case Studies, Equities, Featured, Interviews, The Manual of Ideas, Transcripts

We had the pleasure of speaking with Larry Pitkowsky, managing partner and portfolio manager of GoodHaven Capital Management. The conversation took place at the end of August 2022.

In the following wide-ranging interview, John speaks with Larry about his path in investing, the investment strategy of GoodHaven, the types of businesses Larry has found particularly rewarding from an investment perspective, his thoughts on portfolio concentration and risk management, and three ideas that illustrate GoodHaven’s investment approach.

John Mihaljevic, MOI Global: It is a great pleasure to welcome to the conversation Larry Pitkowsky, co-founder of GoodHaven Capital Management.

Larry, I look forward to talking about your investment approach, philosophy, and perhaps a few ideas as well. At the outset, would you mind sharing a bit about your path in investing and the genesis of GoodHaven?

Larry Pitkowsky: Thank you for having me, John. Some people love to talk about their life story, and while I don’t, I’m more than happy to do it for you and for the benefit of the MOI folks.

I was an undergraduate student getting a degree in accounting with no real passion for accounting. I developed an interest in the financial markets. I wasn’t exactly sure what to do with it, though it was clear I found it much more interesting than a traditional path into the accounting field.

I decided to become a stockbroker, which I enjoyed a lot. I was able to build up a business and continue to explore what the world and the financial markets held. In the meantime, I self-taught myself security analysis. Along the way, I had a brokerage business. It was a mishmash of all kinds of things. I was very fortunate in that I had as part of the clientele some legendary value investors who were a bit older than me. Somewhere along the way, it dawned on me that I was making suggestions on some arcane ideas to them that they were finding interesting. Instead of suggesting ideas to them, maybe I should try and build an asset management business in some fashion.

I moved around to a firm where I could build a small asset management business while still making a living doing all of my normal brokerage things. I started to build that; then, at some point, I joined Fairholme Capital right after it had started. There, I took with me the asset management business I had built. Along with Keith and Bruce, we built a nice business. We did a very good job for clients and shareholders in the time we were all together – 1999 through 2008, when Keith and I became less involved day to day.

Then the two of us decided we would like to build our own firm and launched GoodHaven with the backing of Tom Gayner and Markel in the spring of 2011. We were very fortunate that when we had the idea to launch GoodHaven, Tom said, “Come on down to Hondos in Richmond, Virginia. We’ll have a steak, and we’ll talk about it.” We did, and we’re forever grateful that Markel became our minority partner, and anchor client.

I think we did a very nice job for a while. We had some very solid years with a bit of an uneven period there in the middle. In mid-2019, all of the key people – myself, Keith, Tom Gayner, Dan Gertner, and the team at Markel – were open to making some changes in the structure of GoodHaven. We figured out how to do that in a way that everybody was comfortable with. As 2019 ended, Keith retired from day-to-day activity and remains a supportive minority partner. Around that period, Markel increased the assets we managed for it. I became the majority controlling partner and sole portfolio manager at the very end of 2019. That began what I call GoodHaven 2.0. More recently, in the beginning of 2022, our longtime senior analyst Artie Kwok became a managing director and a minority partner.

I think it’s been an interesting path. I’m very fortunate to have the opportunity that is in front of us. I believe everything that has happened before has provided the opportunity for what is to come as we continue to build GoodHaven 2.0.

MOI: Thank you so much for providing that background. I believe many of our members have been aware of your path and GoodHaven for quite some time. Tom Gayner and Markel are part of the community, so philosophically, there’s a lot of overlap here.

Pitkowsky: Can I do a quick advertisement for Markel?

MOI: Sure.

Pitkowsky: For anybody out there who has a large, profitable, private business that is looking for a home, you should call Tom because our experience through all these different moments with him and the Markel team has been nothing but spectacular. I think that as good as they look from the outside they are better once you get to know them. If anybody thinks they have a large business that Markel Ventures might be a good home for in some fashion, I encourage them to give Tom a call.

MOI: Terrific. I’d love to talk a bit about some of the key principles that will guide GoodHaven 2.0 going forward. How do you see the firm evolving over time?

Pitkowsky: If somebody were to stop me on the street and say, “Could you tell me in a few simple words, without industry jargon, what the heck it is you’re trying to do for clients?” I would say, “We’re in the generating-strong-returns-for-clients-without-taking-a-lot-of-risk business.” You can create a 50-page PowerPoint around that, but that’s the business we’re in. By the way, I think that’s the business most people who are sitting in my shoes are in, or maybe should be.

I joked in a recent letter that somebody once asked how to describe myself to their clients. It was a financial adviser who was going to give us some money. I said, “Smart, honest, and very good-looking.” He said, “No, Larry, I meant what box are you in? Are you SMID? Mid-cap value? Large-cap value or whatever?” I offer that little backdrop because I think it’s been very important here at GoodHaven 2.0 to step away from some of the industry jargon and remember what we’re trying to accomplish for clients and ourselves and how and with what risk mentality.

I also think it’s been important – and I’ve tried to write about it the last couple of years – to remember what value investing is and what it is not. Value investing, in my opinion, is the search for investments where you have a large margin of safety between your purchase price and the intrinsic value. It is making sure you remember the markets are there to serve you, not to guide you, to focus on the fundamentals, to be long-term oriented, and then to come back to point number one, which is to invest with a margin of safety. It also is completely consistent with value investing to invest in high-quality companies that earn good returns on capital and are growing and well-managed.

What value investing does not have to be is having a draconian and negative view of the world. It does not necessarily mean you have to buy the cheapest statistical securities available, regardless of their quality. It does not mean you have to have a macro view of everything going on in the world. Those are not necessarily what the tenets of value investing are about.

In a couple of recent letters, I attached a letter I wrote back in 1998 to my then-fledgling clientele talking about owning high-quality companies but with a margin of safety that earn good returns. At GoodHaven 2.0, which started right as the pandemic hit in early 2020, we used that awful moment for our society and the market collapse in that period to try and upgrade the portfolio a bit, keeping some of those things in mind.

MOI: Would you mind expanding on your investment philosophy a little? What are the types of businesses you have historically found most rewarding for your investors?

Pitkowsky: When I’m looking for something for the portfolio, the first thing is whether it is a business that we have an ability to picture what it will look like three, four, five, or seven years down the road. Do we feel we have some understanding of where the business and the industry are headed? That right away rules out a lot of things that you don’t have a view on or shouldn’t really have a view on. I think it’s an enormous mistake in life to have an opinion about everything, especially when you’re investing.

(1) Do we have a view of where the business is headed in the future? (2) Is it a business that earns above-average returns on capital employed and on equity? (3) Is it run by a management team that we feel is treating the shareholders reasonably well?

Then the question is whether you have a view that’s a bit different from everybody else’s. Most of the time, to get an above-average return or performance, it’s nice to find something you have a view on or an insight into that differs somewhat from the market’s. That’s the opportunity.

Then, you have to say, “That’s all great, but what is the stock market giving me as an entry price?” A lot of the time, it’s not giving you a price that you feel provides you with a margin of safety or will allow you to earn an above-average return, so you stick that on the shelf and say, “That’s an interesting company.” I might say, “Let’s keep an eye on it; who knows?”

That is the type of mindset we’re looking at for the bigger holdings and for most of the portfolio. We will also do an occasional true special situation, arbitrage and liquidations, distressed debt, a workout of some sort where those all of those quality things don’t align but there’s an attractive return we think we’re going to earn with a margin of safety due to some idiosyncratic situation .

What we’re trying to avoid is what I would call – with my undue sophistication – the stuff in the middle. We’re trying not to put together a portfolio of somewhat statistically cheap, not-great businesses run by not-great people but where the entry price in relation to earnings and free cash flow looks good. We’d rather not have it. We’d rather be patient and put together a portfolio of above-average businesses run by above-average people but still with a material margin of safety or something that’s truly a special situation. We’re trying to avoid all this stuff in the middle. In the last couple of years, we’ve been able to do that.

By the way, the GoodHaven Fund put out its semiannual report very recently. Though I’m not super obsessed with short-term numbers, for the last six months, a year, two years, and since we did the reorganization, we’re ahead of the S&P, in some of those periods by a material amount. We’ve still got work to do to improve our since-inception numbers, but we’ve regained a lot of ground and will continue to stay at it.

MOI: Maybe it would be instructive to discuss a couple of ideas that illustrate the approach, if you don’t mind. Anything you’d care to talk about today?

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

Larry Pitkowsky co-founded GoodHaven Capital Management in late 2010 with Keith Trauner, created and began managing the affiliated GoodHaven Fund in April 2011. Larry currently serves as the sole managing partner and portfolio manager.

Prior to forming GoodHaven, he was a consultant to Fairholme Capital Management for approximately two years, and from 1999 through 2008, he held a variety of roles at Fairholme and its affiliates, including analyst and portfolio manager. In addition, for most of the period from 2002 through 2007, he was a portfolio manager of FCM’s affiliated Fairholme Fund.

Larry was also vice-president of Fairholme Funds, Inc., the parent company of the Fairholme Fund, from March 2008 through January 2009. Larry has more than thirty years of experience in securities research and portfolio management across a wide range of companies and industries. Larry has been quoted in a variety of business media, including Forbes, Fortune, The New York Times, and Reuters.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated herein.

Thesis Updates: Deutsche Bank, Holcim, Lanxess, Swatch

October 6, 2022 in Equities, European Investing Summit, Letters

This article is authored by MOI Global instructor Samuel Weber, founder and portfolio manager at Samuel S. Weber Vermögensverwaltung, based in Switzerland.

Samuel is an instructor at the upcoming European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.

The world is constantly changing, and my human brain has an extraordinary ability to create stories and explanations in hindsight that often bear little resemblance to what was actually happening in real-time. Therefore, one of my primary objectives for presenting my favourite European investing ideas on MOI Global is to have a well-documented account of my own thinking at the time of making some of the most important decisions of my investing career.

As I currently have no new investment to present to the MOI community, I decided to update my previous ones. Since presenting Deutsche Bank in 2017, the world has faced a global pandemic, the outbreak of a war in Europe, and the resurgence of inflation, among other things. These are highly significant events in global history that are reshuffling the cards for many investors. It is therefore of prime importance for me personally to see how my investment theses are holding up in this new environment.

I will not repeat what I said in the past on this platform. Enough has changed to focus on providing relevant, timely and new information. For readers interested in hearing my past presentations, they can be found on moiglobal.com. Also, this short article gives a preview of what will be a more detailed presentation next month. I will start with my most recent idea, first reviewing the investment case for Lanxess that I presented last year, then Swatch Group (2020), Holcim (2018) and finally, Deutsche Bank (2017).

Lanxess

Since presenting Lanxess last October, the economic environment has taken a dramatic turn for the worse. As a diversified chemicals group with a significant industrial footprint in Germany, the company is heavily affected by the war in Ukraine. It needs a lot of natural gas to fuel its operations and suffers from the commodity’s high price and possible lack of supply. More generally, inflation imposes significant working capital needs that lower operating cash flows, increase capital invested and decrease the returns on that capital.

Despite facing this tremendously disadvantageous operating environment, the company performs reasonably well. During the first half of 2022, it was able to fully pass on material and energy costs to its customers and increase operating profits by more than 20%. It has published an analysis of the potential costs of factory shutdowns due to a lack of gas, showing that even this adverse and so far hypothetical scenario could be managed with limited profit impact, because the most gas intensive plants are also the least profitable ones. Also, when it comes to gas supply, Germany is divided into two parts, with the East being supplied mainly by Russia, and the West (where Lanxess is located) by LNG from global markets and pipelines from the Netherlands.

Most importantly, the company – under the supervision of a superb management team – continues to deliver on its transformation towards a specialty chemicals company. While there has been some sobering news about Standard Lithium, Lanxess recently announced a joint venture with Advent, allowing it to partly monetize one of its four segments (the weakest one, in my opinion) within the next 12 months and fully monetize it within the next 4 years at attractive valuations, allowing it to deleverage its balance sheet and refocus on more profitable segments. Furthermore, it closed two sizeable acquisitions in its Consumer Protection business, catapulting it into the world leader in biocides and a strong global player in flavour and fragrances.

The valuation of Lanxess is dirt cheap. The company is currently valued at less than EUR 3 billion. After fully monetizing its joint venture and given the current level of leverage, assuming no further acquisitions, the company should be debt free in a few years. On a projected EBITDA of around EUR 1.2 billion, it would then trade on an EV/EBITDA ratio of 2.5 times. The ultimate valuation depends on the competitive strength of the group, i.e., how sustainable its pricing power is and how much free cash flow it will generate. As far as I can tell, an EV/EBITDA ratio of 10 times seems achievable, indicating significant upside.

Swatch Group

When I presented Swatch Group in 2020, two years ago, it was suffering from the effects of the global pandemic and, more importantly, from government-imposed lockdowns. Since then, the company has increased its revenues and profitability significantly. Even during the pandemic, it achieved a healthy level of operating cash flow by selling down inventories, releasing accumulated working capital.

In my presentation, I identified the company’s capital allocation as a material weakness, and this has not changed. Indeed, it got worse. A few years ago, the company engaged in a share buyback to avoid paying negative interest rates on cash assets, giving me hope that, besides statements to the contrary, the CEO, who is a significant shareholder, has a rational eye towards capital allocation. However, today, I am much less optimistic.

Out of total balance sheet assets of CHF 14 billion, inventories account for CHF 7 billion and cash & equivalents for over CHF 2.5 billion, amounting to a total net working capital of CHF 9 billion. Theoretically, the company could monetize its gold and jewellery assets, and, together with its cash assets, buy back more than a third of its outstanding shares, dramatically increasing its earnings per share, return on equity and shareholder value. On a recent earnings call, however, the management team showed no willingness to do such a thing.

Given the size of the amounts involved and the unsatisfactory level of profitability during the past 5 years (which is mainly related to the company’s capital intensity, much of it unnecessary for operational purposes, in my opinion), I can’t defend this observed unwillingness to engage in rational capital allocation any longer. The company’s financial performance could still be bailed out by strongly growing revenues. But relying on such growth to generate reasonable returns isn’t a responsible strategy, least of all considering that first-half-year revenues haven’t grown during the past 10 years!

A lot of economic crimes have been committed in the name of capital efficiency. And I support a reasonable safety buffer. But no amount of safety buffer can provide operational safety in the long-term. Only watch-loving and -buying customers can do that, and no amount of assets on the balance sheet will compensate for a lack thereof. Meanwhile, the seriously depressed capital returns destroy shareholder value with no concomitant benefit.

Holcim

When I presented Holcim in 2018, Jan Jenisch, its CEO, was in the process of significantly transforming the company. He joined in 2017, and today, has accomplished much of what he set out to do. Holcim achieved all its 2022 targets one year in advance. It reset its profitability, doubling free cash flow to over CHF 3 billion, deleveraged its balance sheet and laid the basis for the fourth segment, Solutions & Products, to become a significant profit centre.

The company recently announced the sale of its India subsidiary to Adani Group at twice its own valuation, meaning that it will receive more than 20% of its current market cap in cash while selling only around 10% of its earnings power (and even less of its free cash flow). The proceeds will mainly be used for further acquisitions in the Solutions & Products segment. This divestment is particularly attractive given the significant hurdles the Indian government imposes on repatriating cash from India and the current CO2-related discount that Holcim suffers from in the stock market due to its cement activities (the Indian subsidiary accounts for more than 20% of Holcim’s total cement grinding capacity).

I expect Holcim to continue executing on its transformation, significantly outperforming its 2025 plan, and to generate significant and growing free cash flows in the future based on its hundreds of local monopolies. Jan Jenisch has a proven track record in capital allocation and a massive firepower to finance acquisition, so the majority of Holcim’s activities will soon consist of products and solutions unrelated to cement. Importantly, I also view its cement activities as highly valuable. Not only do they provide the company with significant cash flows that fuel its transformation, they also enable Holcim to get into contact with its customers very early in the life cycle of a building / an infrastructure, allowing it to cross-sell other products & solutions. The valuation of less than 10 times free cash flow and 8 times owner earnings is highly attractive, compounded by a tax free dividend yield of around 5%.

Deutsche Bank

Of all my investment ideas, Deutsche Bank was by far the most controversial. How could I possibly consider investing in a European, unprofitable and criminal bank? Didn’t I know that this company is already insolvent, the value of its assets significantly overstated, its risk management broken and its business inherently unprofitable?

While predictions of an imminent downfall can’t be falsified, I am happy to report that five years after my analysis, I turned out to be mostly correct. In the first half of 2022, Deutsche Bank achieved its targeted level of profitability with a return on equity of 8% and net profit of more than EUR 2 billion, despite absorbing significant costs from its capital-release unit and facing a global pandemic and the recent outbreak of a war in Ukraine. The company is benefitting from a sustainable recovery in trading revenues, the quality of its asset base, rising interest rates and improving efficiency across all business units.

There are still a lot of doubts about Deutsche Bank’s ability to keep up and further build on its recent performance. Europe’s financial industry resembles a construction site, and its banks suffer from material competitive disadvantages (mainly related to their size) compared to internationally active U.S. banks. Many European banks are significant holders of sovereign debt from their home countries that are much less credit-worthy than Germany. And some banks on the continent are in a seemingly never-ending restructuring with no clear solutions in sight.

Despite that, I feel very well about the Deutsche Bank’s prospects, having observed closely its management team, risk management and operational progress during the past 5 years. The return on equity may soon surpass 10%, powered by its sizeable deposits franchise, leading to a yearly net profit of around EUR 6 billion. On this basis, the bank is currently trading at a price-earnings-ratio of 3 times. Furthermore, it will pay out significant dividends and engage in meaningful share repurchases during the next few years, which will further enhance shareholder value.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

Finding Value in European Banks and Other Old Economy Sectors

October 5, 2022 in European Investing Summit, Letters

This article is authored by MOI Global instructor Stuart Mitchell, investment manager at S. W. Mitchell Capital, based in London.

Stuart is an instructor at European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.

“Old economy” earnings continue to impress. Whilst just over a half of all companies surprised in the second quarter, a whopping 100% of energy, 69% of materials and 68% of financial companies beat expectations. And… those sectors make up 40% of our fund today. If we include our shipping investments, “old-economy-beaters” make up just under half of the portfolio.

Our highest second-quarter-earnings-beaters were as follows:

Deutsche Bank +30%
Lloyds +29%
Commerzbank +26%
Intesa +25%
BP +24%
BNP +18%
Legrand +18%
Maersk +16%
VW +11%

The Great Technology Bubble has resulted in the squandering of trillions of dollars of capital in the quest to find the next Amazon or Google. So great has been this squandering of capital that we are now in the situation where many older economy industries such as oil & gas and shipping have been so starved of capital that their supply-demand dynamics are now tighter than anything that we have seen for decades. Indeed, many hitherto well supported companies have been so shunned by investors that they have invested significantly below depreciation rates for well over a decade.

European Big Oil’s capex to remain slightly below $50 billion by 2024E

Sources: Kepler Cheuvreux, S. W. Mitchell Capital.

But perhaps the sector most detested by investors is the banks. The Global Financial Crisis led to significant write-downs of mortgage backed securities, and many were forced to seek aid from their governments.

Write-down ($bn)
UBS 38
HSBC 28
RBS 15
Credit Suisse 9
Lloyds Bank 8
Deutsche Bank 8
Landesbank Bayern 7
Crédit Agricole 5
Dresdner 3
IKB Deutsche Industriebank 3
Barclays 3
Soc Gen 3

Source: S. W. Mitchell Capital.

But at the same time as banks were struggling to meet minimum capital requirements, the industry was then forced to double Tier 1 equity capital to over 13%… And all this happened at a time when interest rates were falling, squeezing net interest margins significantly.

But this is changing. The industry is now benefiting from higher interest rates. As you know, European banks’ funding costs are largely fixed; extra income generated from rising interest rates passes directly to the bottom line. The impact is most dramatic for the German banks: in the case of Commerzbank, a 1% rise in rates will lead to a doubling in net interest revenues.

In addition, banks have also worked hard since the Global Financial Crisis to cut costs through branch closures and digitalisation. And crucially, banks’ balance sheets are now much stronger whilst bad debts have come down significantly and lending standards have been greatly tightened. We have written previously in some detail about this in the recent past. Our thoughts can be found here.

And yet, investors remain reluctant to invest in the old economy. Most investors remain wedded to technology and “growth-at-any-price”. As interest rates fell, many investment managers rushed to brand themselves as growth managers, unaware that they were feeding the bubble further. But the bubble has now finally burst…

At first it was the impact of higher interest rates on the valuation of these fantastically rated companies. But now earnings expectations are also beginning to drop. The result of the wanton throwing of vast quantities of capital at a number of new industries such as food delivery has led to “unexpectedly” fierce competition. This has already resulted in many 70%+ share price falls. But this is just the beginning. In areas like semiconductors the recent doubling in capex spend by the industry could lead to a return to losses for many; most investors find this hard to imagine…

So hard that old economy companies continue to trade at extraordinarily compelling valuations.

2022
PER (X) FCF yield (%) Yield (%)
Oil, metal and shipping 4 24.2 15.5
European IT sector 25 1.8 1.8
Valuation premium/discount (%) -84 -92 -88

Source: S. W. Mitchell Capital, Kepler.

* * *

Finally, I urge you all to read Piers’s new thought piece, The future is on our plate, a thought-provoking examination of the future of how the world produces and consumes its food, and how this will change, with surprisingly drastic investment impacts.

And we will be publishing a further two thought pieces in the autumn. Lukas will be writing on the various fuel options for the next generation of ships, and I will be writing on the level of copper prices needed to generate new investment in the industry.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

Automotive Industry: Attractive Medium-Term Investment Case

October 5, 2022 in Equities, European Investing Summit, Letters, Transportation

This article is authored by MOI Global instructor Ole Soeberg, founder of Nordic Investment Partners, based in Copenhagen.

Ole is an instructor at the upcoming European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.

It’s a well-known fact that component supply for the automotive sector has been under tremendous stress in the last two years. Shortage of semiconductors and closure of production in spring and summer of 2020 caused global light vehicle sales to drop from 90 million in 2019 to 78 million in 2020 and only to make a partial recovery to 81-83 million units in 2021-22. Hence, there’s pent-up demand for up to 30 million units.

There are several factors at play that could be a game changer for the automotive industry. And looking at past periods of slumps in unit sales those periods are followed by three to five years of solid performance for the sector. The 2003 version MSCI World Auto incl dividends outperformed until 2006, while in the version since 2009 outperformed significantly until 2015.

So, will the current slump result in a period of solid outperformance from 2023 to 2028? No-one has privilege to know the future, however there are a few facts and observations that provide direction:

1. Current estimates are for unit sales suggest 100-million-unit sales in 2025 or and CAGR from 2022 of 8% per year.

2. The share of electric or hybrid electric will rise to at least 25 million units in 2025 from 5 million units in 2021 or a 50% CAGR.

3. Consumers in general are in a financially healthy position with good employment situation and spare cash after the lockdowns, so a new light vehicle is within reach.

4. The average age of light vehicles in large markets like USA and parts of Europe is 11-12 years versus average life time of 15 years, hence there’s an increased potential for replacement sales.

5. Automotive penetration in emerging markets is still relatively low and leaves a long run-way for future light vehicle unit sales.

The skepticism towards electric vehicles, i.e., range angst, lack of charging infrastructure and unclear resale prices held back consumer appetite some years ago. Those arguments for being reserved has changed in the last couple of years and electric car adoption is rising fast. Simple micro-observations from friends and family now show that a two-car family have or are in process of changing to at least one electric car. And once you get comfortable with the convenience of the home charger, there’s no turning back.

How will the carmakers perform in this upswing?

The carmaker landscape is in constant change and has been from the early days. The new players like Tesla, Nio, and Fisker are challengers to the traditional players like Ford, Toyota and Volkswagen. The incumbents have been a bit slow on their feet to embrace the future of electric mobility. By now the incumbent carmakers have woken up helped by Tesla and the transition to electric is now in the fast lane.

A new production line for a new model is estimated to costs €0.5 to 1.0 billion, while a facelift and engine/interior upgrade is estimated at €100 million. The incumbent car makers know their Internal Combustion Engine (ICE) cars have limited future, so those models will not see much more than required engine improvements and other changes to live up to regulation and some customer appeal. All new models will be electric and lots of the new instrumentation features will not be available even in the facelifted ICE cars.

As all the big capex plans are directed towards electric, there’s a big productivity opportunity. Car making is a very complex system of “just-in-time”. An ICE car has 25,000-30,000 components that need to at the right place at the right time, while an electric car has only 11,000-12,000 components. Less components means faster assembly and hence better productivity.

Carmakers’ gross margin runs around 20% and R&D, sales, marketing, and administration at 12-15%. Tesla gross margin is closer to 25%, so first movers from the incumbent side should be able to transform the simplicity advantage of electric vehicles into a gross margin improvement. This is not reflected in current consensus forecast.

How to invest in this opportunity?

When Apple launched the iPhone in 2007 close to nobody guessed unit sales would jump to more than 200 million per year and in that process Apple and Samsung would take down the king of the hill at the time, Nokia.

I don’t think the automotive industry will see a similar dominance by one player that is able to sell its product at a significant premium simply due to its looks and easy user interface. But you never know.

People’s relation to automotive brands goes from indifferent to “would never set foot in any other vehicle” and is embedded over several decades. Smartphones is after all only 15 years old, so it was a brand-new category.

One investment road is simply buying the give largest automakers measured by unit sales or revenues, buy an ETF can gives general exposure. Either will give exposure to the expected volume growth for the next three to five years.

Another investment road is to find a car maker with a clear vision of the future and yet not priced insanely or at least out of reach for investors that consider valuation as part of the investment criteria.

I have been looking through the sector and will present my best pick at European Investment Summit 2022.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

Patrizia SE: Preview of Idea Session at European Investing Summit 2022

October 4, 2022 in Equities, European Investing Summit, Ideas, Letters

This article is authored by MOI Global instructor Gokul Raj Ponnuraj, portfolio manager of public equities at Bavaria Industries Group, based in Munich.

Gokul Raj is an instructor at European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.

Patrizia SE (Germany: PAT1) is a top-three European real estate asset manager with a strong balance sheet (25%+ of market cap as net cash). The shares recently traded at 0.35% of AUM and 0.7x book value, despite having an owner-operator who has compounded book value per share at 15.5% over the past decade.

Patrizia has transformed from being a capital heavy real estate operator into an asset light investment manager with 56 billion euros of AUM. It is now a scaled-up platform as the firm has grown AUM at 24% CAGR (including inorganic) over the last decade. Over 80% of their AUM is in perpetual or 10 year+ vehicles and that provides strong resiliency to the business through a predictable management fee stream.

Patrizia has a conservative culture anchored by the 54% ownership by the founder. Over 80% of the real funds are in the Core & Core+ categories compared with just 20% in the higher risk value-add segment. They do not accrue carry income to the financial statements until realized except in special-purpose vehicles where IFRS forces them to. The leverage on their properties is also lower than peers with an average of 35% LTV.

The long-term performance of their funds is healthy with a 4.2% out performance versus benchmark. Their valuation marks are conservative as they have always used a long run average discounting rate even when interest rates fell below zero. The unaccounted carry provides buffer to the current valuations.

On a normal year, transactions are 10-15% of AUM and that provides Patrizia with lucrative fee income along with an ability to book carry income. With the current market uncertainty, I believe that the transaction and performance fee streams should be weak for the next few quarters. The management expects to get to 250 million of management fees yearly in the medium term and that should provide strong stability to profitability.

The firm does not need any capital for growth and hence I would expect strong dividend pay outs going forward. On incremental AUM, the firm will be able to earn almost 20 bps per year and thus if the firm is able to grow the AUM to 80 billion as the management wishes, I do see a strong growth in operating profits. Once the current bearish sentiment around Europe turns around, I believe Patrizia’s shareholder returns will come from all the 3 levers – revenue growth, margin expansion and valuation re-rating.

The market cap of Patrizia is around 900 million euros. The net cash on the firm’s balance sheet is around 250 million euros. Their co-investment portfolio is worth 550 million euros. The majority of this is linked to Dawonia which is a solid Munich residential real estate portfolio that is currently marked at a 3%+ rental yield. With increasing cost of construction and under supply in Munich, there should not be any big mark down in this value.

Hence, the asset management business with 56 billion of AUM is available for a partly 200 million euro valuation (35 bps of AUM) which is several times cheaper than private market transactions in the alternate asset management space. Even on traditional metrics, the P/B is 0.7X, tangible P/B is 1.2X, EV/ EBITDA is 6X and dividend yield is 3%. Even though we await markets to value them as an alternate asset manager, there is strong downside protection due to the assets. Thus, the Risk-Reward is asymmetric for an investor at the current price.

Catalyst

Dawonia portfolio sell down at current market value would release 500 million euros of capital, leading to net cash on balance sheet rising to 80% of current market cap. The end date for the portfolio is 2023 but could be extended if market conditions are not favourable.

Risks

There will be headwinds in the transaction and performance fees along with potential mark downs in the co-investment portfolio. In the long term, the company needs to fix its cost structure and demonstrate operating leverage to get good valuations. Cost to Income ratio is still elevated despite scale. The management in my view have slightly overpaid for inorganic growth in the past. They are spreading themselves thin with expansion into newer asset categories and geographies. The firm should attract strong investment talent to be successful and their conservative culture might prove to be a deterrent.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

Peter Gustafson on Long-Term Co-Ownership of Great Businesses

October 2, 2022 in Audio, Equities, Full Video, Wide Moat

Fellow member Peter Gustafson of Denmark-based Prospect Family Office has kindly agreed to share his talk on implementing Warren Buffett’s investment principles with the MOI Global community. Peter gave the talk at Bob Miles’ Value Investor Conference in Omaha in 2022.

The presentation answers the following key questions:

  • What is a possible “end goal” of a private investor?
  • What are the characteristics of great businesses?
  • How do we know those businesses will give us the results we need?
  • Where do we find such companies?
  • When should we actually invest in those companies?
  • How long should we hold on to those investments?
  • When is the right time to sell?
  • What is the most important success factor of all?

Throughout the talk, Peter addresses the most common mistakes investors make at each stage of the investment process.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

Peter Gustafson is the founder of PROSPECT Family Office. Since 2008 he has been a full-time investor and co-owner of a small number of businesses. The track record for his family office set-up has been an average return of about 18% annually after all costs and taxes. Prior to his investment career, Peter spent sixteen years as an entrepreneur and business owner. To prepare for working as a full-time investor Peter spent two years studying Warren Buffett and then implemented Buffett’s investment principles and values in his own investment activities and portfolio. Earlier in his carrier Peter held the position as business editor at Berlingske, one of Denmark´s leading newspapers. Peter holds a master degree in finance and capital markets from Copenhagen Business School and also studied under Professor Bruce Greenwald at Columbia Business School. Peter lives in both Denmark and Singapore.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated herein.

Thought Exercise: Explaining the Global Macro Situation to a Martian

October 1, 2022 in Equities, European Investing Summit, Ideas, Letters, Macro

This article is authored by MOI Global instructor Roshan Padamadan, chairman of Luminance Capital.

Roshan is an instructor at European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.

It is October 2022, and it has been a year full of macro events – the Russian invasion of Ukraine; rising and persistent inflation; sharp interest rates hikes in the US; massive devaluation in the currencies of Japan, Eurozone, and the UK; as well as high commodity prices, while at the same time, expectations of a recession in the US are widespread.

I wish to approach the macro situation in an unconventional way: Let’s explain it to a Martian.

We are usually so caught up in the micro that we miss the macro wave(s).

Let’s consider the key ingredients of the last two decades:

  • Bursting of the US housing bubble (2006-2007)
  • Subsequent bailout (2008-2009)
  • Covid pandemic (2019-2020)
  • Stimulus packages (2020+)

These crises were large, but the impact was contained by massive stimulus packages, involving major increases in the Fed balance sheet.

Dear Mr. Martian,

We use untethered currencies on earth, i.e., no currency is pegged to a fixed measure of value. At one time we used gold, and we measured the strength of a country in part based on its gold reserves. We went off the gold standard in 1971, but still keep track of the size of a country’s gold reserves.

Time dilation. Things can be moved back and forth in time. The impact was contained, yes, but the impact was just spread out. Here are the questions we need to understand:

  • Who paid for the 2008 bailout?
  • Who paid for the 2020 stimulus packages?

Most people on earth will say the government. But the government is a framework, there is no real person, with a big fat purse and a big heart. It is an artificial “company”, with a balance sheet and P&L and cash flow, just like any company. True, it has some special powers such as it can enact laws, and raise or reduce taxes, etc.

I have found it useful to think of the government as a passthrough mechanism, doing swaps all the time between groups of people, both present and future groups, acting as a giant exchange. It can and often does pass through things to the next generation, who do not yet have voting power.

Mr. Martin, please understand: While the government moves value from one set of people to another, the direction of money flow is determined by the political structure, the current ethos and the overall culture of the nation. An extreme form is where all wealth moves to the top (a dictatorship or an absolute monarch). No major economy on earth is run that way now. Some move money from the masses to the rich. Some move money from the rich to the masses. Most do both at the same time, albeit in unequal amounts.

For the 2008 bailout, the answer is that the savers paid for the bailout. They received and continue to receive sub-par returns on their savings dollars. The extra margin was used to recapitalize the banks – and the US government made back its money when bank share rose (as it got paid in warrants). (Ah, yes, Mr. Martian, they became an investor in the sector they rescued).

Mr. Martian, the governments can do time dilation – they can move things from the present to the future. A trillion dollar bailout can be arranged in a day or a week, with a view to recover it over the next ten years or so.

Unlimited credit is one way where time dilation comes in. People who play Monopoly (a board game popular on our planet) in a friendly way realize that the game never ends if you give unlimited credit to your broke friend. The game goes on ad infinitum until someone cuts the credit line, and someone exits the game having run out of money.

Mr. Martian, our government can do “unlimited” (not so, I will explain shortly) credit, and thus can move things from the present to the future. This is how the massive pain of 2020 lockdowns was averted – we gave people money. But the (small) businesses which did not see footfalls and still kept their shops open for weeks and months in the hope of a quick recovery, still suffered massive losses on their business (and personal) balance sheets. Hordes of shops closed down and I see empty stores in so many malls across Singapore, New York, St. Louis – in 2022.

This is a delayed recession. Airlines may be running full, but their balance sheets are debt-laden, and they are in worse shape than before. Current business boom cannot substitute for two years of lost revenue and massive losses. Covid-19 should have caused an immediate and massive recession – our governments moved it out by a few years.

Our governments are still limited in that they have limited resources – all rescues must be paid by someone, and our savers are already only getting only ~0.1% for their assets, still paying for the last housing crisis bailout, so there is no one else to take money from, for a continuous bailout. Therefore the government’s unlimited credit potential is a fallacy – it is indeed limited.

What happens next, you ask?

Next, we will tax the masses. We will raise GST or equivalent, asking consumers to pay. Even Singapore is raising its GST from 7% to 8%, come 1 Jan 2023. That’s a 14%+ increase. (Singapore is one of the few countries that run a government surplus. Most countries on earth spend more than they earn).

New taxes will be introduced across countries.

Who will it hit? All.

Who will pay more? The people with assets. Naturally.

Mr. Martian, why does Europe buy its energy from a country it is sanctioning, you ask?

This one I have not figured out yet. And this is one reason why the war may end sooner rather than later. A Russian retaliation by cutting off gas supplies to Europe in winter will be devastating. Germany, Italy, Netherlands, even Switzerland import most of their power from Russia. Gas pipelines are interconnected, so even if you are not connected to Russia, when Russia cuts off gas, all of Western Europe suffers. The Eiffel Tower now shuts off its lights an hour early, but this is a drop in the ocean compared to what France and rest of Europe will have to endure if the war stretches to the winter. I see zero appetite for such sacrifices.

What if it doesn’t end, you ask?

Well, this will be the last time I write a macro view.

Still, what would I do, you ask?

Mr. Martian, in a true world war, you only true capital will be your human capital (what you know). And your social capital (who you know). Who can you count on when you have nothing at all? Can you make friends quickly in a new country(planet)? Do you have friends all over the world? Are you resourceful and can start from zero in a new place? These will matter most.

Most of your material possessions you cannot take with you if you are displaced. Your bank assets may be frozen or inaccessible from a foreign county. You can take a few pieces of gold, or sneak jewels sown into your clothes. Rolex watches and cigarettes may become informal currency in a refugee camp. But there are limitations to such plans. You may still be robbed if you are the only one who thought of some smart way to take gold with you. You may be robbed if you are disliked. Ultimately, it is the human capital and social capital which will matter.

Where would I go, you ask?

Mr. Martian, if WWIII really breaks out, I would head far away, to New Zealand, if the borders remain open. If it weren’t for 75% of its gas coming from Russia, I would have gone to Denmark. It was the only country where the Danes united and saved the Jews in WWII. I am not a Jew, but I like the spirit. An entire country working as one, to save its Jewish population from Hitler’s purges, shipping them away to Sweden. It is a gripping story for another day.

I exaggerate, you say, with talks of migration and refugee camps, etc.?

Mr. Martian, people are moving away from their homes in Russia to avoid a compulsory military draft. 100,000 people have moved in just two weeks, according to estimates. We must keep following all the micro dots, to make sure we do not miss the macro wave.

I will end with an investment angle.

Mr. Martian, the reason the US dollar is so strong is simple: it is the economy with the most dynamism. Printing more money does not create true value – it is only created by productivity gains, driven by innovation. Technology stands for a better way of doing things – in any sector. Tech is not limited to Technology names. It can be applied to a copper smelter, a printing press, a miner, and not just to a company figuring out a better way to show you more relevant ads.

By and large, US has the best tech – across sectors. The labor force is nimble, agile and highly organized and productive. I have personally worked with Japanese, Indian, German, British and American companies. I can vouch for the immense productivity at the American ones.

So, you see, I put the strength of the dollar on the dynamism of the American economy. True, it has its challenges, but it is the most likely to address them, adjusting and innovating.

Thanks for the chat, Mr. Martian. I hope you got some insights.

We are seeing the effects of a delayed recession, caused by time dilation. We must accept the pain of higher interest rates- it is the cold water needed to cool down the economy. Our governments do not have unlimited firepower of any sort.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

MOI Global