Keith Smith of Bonhoeffer Fund discussed his “velocity in fragmented markets” framework and presented his theses on Cambria Automobiles (UK: CAMB), At Home Group (US: HOME), and MMA Capital (US: MMAC) at Best Ideas 2021.

Thesis summary:

The velocity of sales in fragmented markets has become an increasingly interesting area of study when it comes to identifying growing firms. Fragmented markets provide the opportunity for above-market revenue growth rates in mature markets, and consolidation can provide increasing margins in businesses with fixed costs via economies of scale. The Internet has provided new distribution channels for goods and services and thus has fragmented the traditional distribution market. The incumbents who can adopt online innovation will be in the best position to gain new customers in markets they were previously not reaching.

Velocity of sales is how fast sales are made in a given year. Velocity multiplied by the net income margin times leverage is equal to return on equity. Margins can be enhanced by economies of scale in fragmented markets. Examples of these types of businesses can be found in auto dealerships, equipment leasing segments of retailing, like home décor retailing, and specialty lending. Three examples of velocity in fragmented markets are Cambria Automobiles, At Home, and MMA Capital. Each of these firms has above-industry average growth and the ability to continue that growth into the future.

Cambria Automobiles is a UK auto dealer operating in a fragmented industry (auto dealerships). The top five firms control 16% of the market. Cambria has been growing via acquisitions and by starting greenfield dealerships. Leverage is obtained via floor plan financing. Cambria has the highest velocity (inventory turns) and profitability among UK car dealers despite not being the largest dealer. Given Cambria’s small size, it only has to build/buy two to three dealerships per year to maintain its growth rate. Thus, Cambria has the ability to continue growing at above-industry rates. The shares were recently quoted at a modest earnings multiple of 6x.

At Home Group is a US home décor retailer operating in a fragmented industry. The top five competitors control 35% of the market. At Home has a unique concept as a self-serve décor retailer, so it is much like Costco, with large stores that have most of the merchandise on the floor. At Home has a low-cost real estate and operations strategy as compared to its competitors. At Home has one of the higher margins among competitors and, with increasing inventory turns, generates a high return on equity. At Home has ~200 stores and management feels that unit slowdown will occur at ~600 stores. It plans on opening 20 stores a year, which should generate 10% unit growth with 3% to 6% same store sales growth. The IRRs on new store openings range from 40% to 125% per year. Thus, At Home has the ability to continue growing at above-industry rates. The shares were recently quoted at a modest earnings multiple of 9x.

MMA Capital is an alternative lending fund operating in a fragmented industry (solar development loans). MMAC has been growing by originating loans into a market that is growing 15% per year. Leverage is obtained via debt at the corporate level, costing 4%. The loans are yielding 11% on an unlevered basis, and earnings are retained as loan demand is high. The team originating these loans has not had a loss on any loan since beginning in 2015. Historical book value growth has been 22% per year. Thus, MMA Capital has the ability to continue growing at above-industry rates. The shares were recently quoted at a modest earnings multiple of 8x and a discount to book value of 35%.

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About the instructor:

Keith Smith, the fund manager, brings over 20 years of valuation experience to the Bonhoeffer Fund. He is a CFA charterholder and received his MBA from UCLA. Keith currently serves as a Portfolio Manager at Bonhoeffer Capital and was previously a Managing Director of a valuation firm and his expertise includes corporate transactions, distressed loans, derivatives, and intangible assets. Warren Buffett and Benjamin Graham’s value-oriented approach of pursuing the “fifty-cents on the dollar” opportunities, underpins Keith’s investment strategy. The combination of his experience and track record led Keith to commit most of his investable net worth to the Bonhoeffer Fund model.

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