Portfolio Concentrated in Deep Value Micro-Caps

Maui Land & Pineapple (MLP) was the Fund’s top performer, with Precision Auto Care (PACI) and Scott’s Liquid Gold (SLGD) also contributing to the positive quarterly performance.

Maui Land & Pineapple’s share price increased after the company announced it had monetized additional real estate within the Kapalua Resort and had repaid nearly its entire debt balance.

Precision Auto Care moved sharply higher after the company announced it had received a buyout offer from Icahn Enterprises at nearly a 100% premium to the prior share price. Our investment thesis in Precision Auto Care was highlighted in our Q1 2017 letter. While the timing of our prior letter was fortunate, the acquisition announcement was a special one for our team as a mutual interest in Precision Auto Care led to the initial introduction between Nicholas Bodnar (our research analyst) and myself.

Scott’s Liquid Gold advanced after reporting strong Q1 earnings which were driven by the solid performance of the recently-acquired Prell and Denorex brand names as well as continued growth from Batiste dry shampoo and Montagne Jeunesse face masques.

The Fund ended the quarter with 16 companies in the portfolio. The largest position was 15% of the portfolio and the top five positions represented 52% of the portfolio. The Fund added one new company during the quarter and also exited one. By sector, 20% of the portfolio is invested in water assets, 19% in real estate (primarily land), 13% in energy, 8% in consumer products, 7% in retail, 5% in media, 3% in industrials, 3% in defense, 3% in gaming, and 20% in cash. The portfolio consists entirely of deep value micro-cap companies that offer investors both upside potential and a substantial margin of safety. The average portfolio company has a Price/Book ratio of 1.2x and trades at 8.5x trailing EBITDA. These valuation metrics compare favorably to the S&P 500 which has a Price/Book ratio of over 3.0x and an Enterprise Value/EBITDA ratio of over 13.0x. The portfolio has a weighted-average market capitalization of $143 million and an average enterprise value of $125 million. Of note, all 16 of our portfolio companies have no net debt on their balance sheet, which we feel highlights the risk-adverse nature of our security selection process during a period of excessive liquidity and financial leverage.

During the quarter, we filed two Schedule 13-G forms highlighting our ownership interests in AMREP Corporation (AXR) and Optex Systems Holdings (OPXS).

We provided our investment thesis on AMREP in our Q1 2015 investor letter and the company continues to be one of our key holdings. We have been impressed recently with AMREP’s ability to repay over $12 million in debt from free cash flow generation in fiscal 2017 and continue to find the company’s valuation to be very compelling.

In this quarter’s letter, we highlight our position in Optex Systems Holdings. Despite the company’s small size, we have been built a meaningful position and are optimistic that the company will continue to contribute positively to our portfolio.

This post has been excerpted from a letter of Gate City Capital Management.

Performance for the period from September 2011 through August 2014 has undergone an Examination by Spicer Jeffries LLP. Performance for the period from September 2014 through December 2016 has undergone an Audit by Spicer Jeffries LLP. Performance for 2017 is unaudited. The performance results presented above reflect the reinvestment of interest, dividends and capital gains. The Fund did not charge any fees prior to September 2014.The results shown prior to September 2014 do not reflect the deduction of costs, including management fees, that would have been payable to manage the portfolio and that would have reduced the portfolio’s returns. Actual performance results will be reduced by fees including, but not limited to, investment management fees and other costs such as custodial, reporting, evaluation and advisory services. The net compounded impact of the deduction of such fees over time will be affected by the amount of the fees, the time period and investment performance. Specific calculations of net of fees performance can be provided upon request.