After a absurdly strong 2013, the market had another great year. The S&P500 index gained 11.39%. Our portfolio returned 46.61%. Since 2009, the market has returned 16.74% compared to our 25.30% annually compounded rate.
The outperformance was largely due to our focus on positions that were initially not discovered by the industry but slowly started getting more eyeballs. In general, we have started to look at companies where we have an edge. Given my small capital base, it has made it clear that I have a huge advantage where the market is not looking. This is in smaller cap companies and companies that are going through transformations.
Although 2014 was a good year, I think we should be able to beat the market given our current portfolio and be able to beat the market at a wide margin. I wouldn’t be surprised if 2015 results in similar returns as 2014. Although we are having a hard time finding new ideas, so once our current holdings work out it will be tougher to deploy the cash elsewhere.
One of the changes I made going into 2013 was fixing two of my big mistakes: being too lazy w/ my position and not focusing on “why”.
In the past I had fallen in love w/ my holdings. My biggest mistake was Goldgroup Mining. Even though I had friends bring up the negatives for the company, I was blind to my position. I kept a closed eye to any analysis of the company that was negative. I was too lazy to act even though it was clear the company had large debt issues and need to constant capital. Another mistake was Dolan Company. Where the negatives of the company’s revenue stream was discussed regularly in the conference calls. Although I heard these issues, I was blinded by the love of my holding.
The second mistake was never asking “why” I’m finding this company for a bargain. Why is the company so cheap, if my thesis is correct. This is also where I’ve realized my edge lies. For example, when I bought BAC Warrants it was clear why it was cheap. The market hated the legal issues and was too scared by the potential large payoffs. So the edge lied in looking past these issues and seeing the legal settlements had always been done for pennies on the dollars. Also the brand had huge cash generating potential once these one-time issues were resolved and the interest rates increased. Similarly, in 2013 I bought XPEL. This was a micro cap where not many were looking at. The company’s shares were extremely illiquid, many days going through no trades. Although the company was generating good cash flow, had a dominant position w/ its software, the brand was growing, and the industry was growing rapidly. There were huge tail winds for this company’s product. In both these situations, asking “why” gave me a valid reason where I could benefit on buying the shares and waiting for the market to come around.
Going forward, I’ve decided to focus on two type of investments: ignored companies and companies going through transformations. XPEL is a great example of “ignored companies.” ID Systems is a company going through a transformation w/ the co-founder coming in fix operations. For the most part, I’m finding more of these ignored companies. Although when we do find companies going through transformations we are buying a huge position.
A quick analysis of some of my current holdings:
XPEL: This is once an ignored company that is finally getting eyeballs. Once this company gets uplisted so funds can buy, the stock will have an unique situation. The insiders own over 40% of the shares and you have early investors owning around 10-20%. So the float is very small for funds to build a position.
The company’s revenues are growing rapidly and there is still huge growth. The international market is starting to get to a good size and I believe the international revenues will eclipse the US revenues. The company’s owned stores make huge cash and as the company builds more of these we will see large cash increases. The company’s growing cash balance will make the balance sheet a weapon, as M&A will pick up. I expect the company to spend lot more on international M&A than US M&A.
ID Systems: This is a company that has been going through a transformation w/ the co-founded stepping in to be CEO. The company is expected to finally be EPS positive in 2015. Also they have a very good operating leverage where additional revenue growth will have big impact on cash and earnings. I think 2015 will be very good for the company, as revenue will increase and company will be profitable. Also, this company is going to be a cash machine with little need for capital.
Sevcon: This is a company that is ignored by many. There is little trading volume, w/ Gabelli owning over 50% of diluted shares. Also the company has huge operating leverage, so cash generation won’t show until you see revenue hitting the income statement. Although, if you look at the prior year financials you can see the company has spent quite a bit on R&D. The fruits of the R&D are close to hitting the financials. We recently saw some fruits of it with the first sales deal for the China JV and a large $50 million contract w/ a Tier One Chinese auto manufacturer. Also, the majority ownership by shareholder friendly fund will ensure that the poor management team doesn’t waste time or shareholder capital.
I haven’t found many new ideas to add to the portfolio. I have made some changes in late 2014, most of them haven’t been large positions.
I sold out of 1347 Property Insurance and Kingsway Financials. I sold out of 1347 right after the news came out that they pulled out their application for the Florida market. The company’s decision not to pursue the opportunity in Florida was a big change in how I had envisioned the investment thesis working out. As for Kingsway Financials, I found other opportunities where I think the odds are better for me.
I bought a position in Sevcon. This is an obscure company that is not followed by many. Although there has been a major change with Gabelli Funds owning a majority of the shares and Ryan Morris as the Gabelli elected activist on the Board. The company is going through a transformation with Gabelli leading the investment into R&D. The company has a JV with a large Chinese manufacturer that should boost revenue. Signs so far show that the company’s transformation is going well and we are starting to see new sales coming our way.
I have also bought 3 other positions that I will leave undisclosed for now.
In 2013, we returned 19.46%. This is much less than what S&P500 returned, 31.90%. I’m definitely not happy with the large underperformance. Albeit, it is the long term track record that matters.
What is the lesson learned from 2013? A quote from Allan Mecham, “I think if investors adopted an ethos of not fooling themselves, and focused on reducing unforced errors as opposed to hitting the next home run, returns would improve dramatically.”
In an environment where the market is up 25%, making money is easy. For me to under perform in this market, the reason was our unforced errors. It was the positions where we tried to have huge hits in a short term but ended up realizing a loss. These positions added up to substantially weigh down on the good performance from our best picks. For example, we took a trading position in a company. The rationale was that a specific event was likely to happen and the my take was the market would react pleasantly with the event. The event came and went but the market didn’t budge. I closed this position two months later, taking a big hit. This one position had a negative 1% impact on our 2013 performance. These are unforced errors where I could have avoided them by not trading based on what the market would do.
Lesson learned: In each case I was enamored by the potential gain that I didn’t even focus on what would occur if the market didn’t act as I expected. In most of these cases, greed tends to make the mind act fast. As Richard Thaler would say, the Automatic System becomes too strong that the Reflective System doesn’t get a chance to think. Interestingly, it is in these special situations where I expected huge returns in a short period that I tend to make these mistakes. When looking at investments that you expect to pan out over years, the Reflective System has the ability to think through the decision.
The other thing that I had a negative impact on our performance was poor picks from 1-2 years ago that we closed in 2013. Dolan Media was a stupid mistake that we should have closed long time ago. Instead we waiting until Q1 ’13 to close the position. The stock was down almost 50% in the first quarter. Similarly, Yukon-Nevada was another mistake that we finally closed in 2013.
As I look at my current holdings, I’m very happy with what we own. I can see myself owning these shares for multiple years, as there is huge upside for these positions. I expect the portfolio to out perform the market.
In 2012, we returned 11.7%. This is less than what S&P500 returned, 16%. Any underperformance is not to taken lightly. Although my performance was negatively impacted by one big holding.
In early 2012, I loaded up on Yukon-Nevada Gold. I expected certain catalyst to play out in the year, which would have moved the stock price dramatically. Although as the year unfolded the catalyst didn’t pan out as expected. I had built a huge position in YNG at the start of the year. At the end of the year I exited most of my holding. The exit price was the same as the entry point. So there was no realized loss. The biggest loss, and the big negative impact, was the opportunity cost. This one holding had a 0% for 2012 (for the position I bought and sold in 2012, the position that I still hold is under water). This had a big negative drag on what was an otherwise good 2012.
Although 2012 returns were hurt by the heavy concentration, I haven’t shied away from big bets. I ended 2012 with 3 positions accounting for over 60% of my portfolio. I would consider buying more of these 3 positions if they get cheaper. One of my take away from 2012 is to be more concentrated, given my small asset base to begin with.
Quick thoughts on my holdings:
Bank of America: The company has turned the corner and has put a majority of its legacy issues behind it. 2013 will be the year when the company increases its dividend and potentially has a buyback of shares. 2012 was great for the stock and warrants, up over 100%. I expect 2013 to be great also, but not similar to 2012.
Kingsway Financial: The company has 2 major investors pushing for change. The management team has been making good decisions in fixing the company. I like the moves they have made and expect 2013 to have significant impact on their operational numbers.
MBIA: We bought this position in late 2012. The play here is clear, BAC & MBIA will settle for substantial amount for MBIA. MBIA will be able to get back to writing its traditional business. Once this occurs the stock is worth multiple of current price.
Veris Gold: The company has finally turned the corner. The new plant is up and running , company is cash flow positive, and production is growing. Once they get the toll milling agreement, the company will be generating substantial cash flow. We will wait patiently until the cash starts coming and the market realizes the value.
Dolan Company: This hasn’t worked out as I had expected. The company’s acquisition of the foreclosure business looks like a bad bet. Although I like the eDiscovery business. We will wait to see the quarterly numbers to decide what to do next.
Goldgroup Mining: It is amazing to see the amount of insider buying. Per my calculation, voer 2% of the company has been bought back by insiders in the last few months. I have a hard time understanding who is selling these shares to insiders. This is a position that has a specific catalyst. I expect the stock to move in early 2013.
Taro Pharma: We are just patiently waiting for Sun to make its next offer. We believe Sun is going to take Taro private. The longer it waits the more expensive it can get.
The year started out with great promise. The market was up double-digits in the first quarter. My holdings were up substantially to start the year. There were clearly many macro events that could have raised concerns for the market. I was aware of many of them, although I do not make investment decisions based on macro events. As uncertainty and fear took over, the market got hit hard. My investments weren’t immune to these concerns. In the end the market was basically flat for the year. My portfolio had a negative 20.57% return for the year.
Although I’m disappointed by the negative return, these are for the most part unrealized losses. I don’t see any one year’s return as having a big impact on the long run. Infact, years like 2011 (and 2009) are the best time to go shopping. And I was definitely shopping. I build up large positions in multiples companies that were hit hard (Yukon-Nevada and Bank of America). Although I suffered in the short-term from buying these positions, I believe in the long run they will help in substantial out-performance over the market. A big reason for the 2011 under performance is due to buying equities that kept getting cheaper. For example, we started buying Bank of America Warrants at $3.50. When it got cheaper, we bought more at $3. As it got even cheaper, we were buying more at $2.60. It got to all-time lows of $1.96.
Was I wrong in buying as it got cheaper? Well, only time will tell. So far, in the first 10 days of 2012, the warrants are back up to $3 (a 50% jump in 10 days). If I’m right, then my investments will work out over the next couple of years and the performance will show when compared to the index.
In 2011 the biggest detractors were Harvest Natural Resources, Yukon-Nevada Gold, Dolan Company and Bank of America Warrants. The big winners were ATS Corp, Harris Interactive and Taro Pharma.
In December of 2011, I sold out of Howard Hughes Corp and Tecumseh Products. I believe both of these companies are undervalued at current prices. Although some of my existing holdings were too cheap. I was buying more Yukon-Nevada and Bank of America. I expect to be buying more of both of these companies in early 2012. I would like to buy back both HHC and Tecumseh. It will depend on how my current holdings work out and where HHC and Tecumseh are at that time.
The funny thing about “New Year”
It is interesting to watch how a “New Year” has an impact on human behavior. Since my high school days, I never understood the circus around New Year’s. I understand it is the start of a new year but human behavior towards this event is mind-boggling.
You will see individuals acting as if the start of the New Year is an opportunity to start fresh. What they couldn’t accomplish in the past year, now with one change in the Earth’s rotation will make it happen. Individuals start acting as if the past is something that can now be forgotten and erased as they have now entered a new year. What they had procrastinated for years will be accomplished.
It is not only individuals that par-take in these bizarre actions. Companies are even more weirder. From an accounting perspective, the company closes its books and starts off fresh. The company creates a new budget and the entire company gets focused on these new numbers. The behavior from management is to forget the past year performance and start focusing in a new set of numbers that start from zero. The entire company starts working on these new set of numbers. It is a mindset that believes there is no continuity between last year’s performance and the new year. An amazing play on the mind happens that doesn’t allow for any connection between what happened in the prior year and what will be achieved in the new year. It is a belief that the worst from the prior year ended with the prior rotation of the Earth. The new rotation is a fresh start.
For insurance companies, the reserves and poor performance from last year is almost ignored as the company starts looking at the new year’s numbers. It is as if the premiums that resulted in poor loss ratios in the prior year, for some reason will not apply in the current year. Management creates new monthly variance reports to analyze current month and current year performance to prior year. The variances imply a distinction between prior year and current year. In reality these are bogus variances that actually don’t make any sense. These implied assumption that these set of numbers, from current year and prior year, have a distinct set of customers, economic conditions, different pricing, and a new weather condition.
In fact these type of fallacies happen in majority of companies and in all industries. The quarterly and annual numbers have an implicit assumption that there is actually a cut-off period. That the business starts fresh at each period and that prior year conditions will for some reason not carry forward.
Similarly, reporting annual performance implies that there is a certain cut-off for our results. As if, the investment performance from prior year doesn’t not impact the new year’s performance. In fact, it is the opposite that is true. The performance from prior year has a big impact on the new year. Companies that have been mis-priced in the prior year are still mis-priced in the new year. If a company has a fair value of $1 but ended the year at 20 cents, then the gap between the price and fair value doesn’t change at the start of year. Similarly, the difference between the fair value of my holdings and the market price continues to the new year. Although 2011 was a bad year for the holdings, I believe as long as these companies delivery on their plan the market will sooner or later react to this difference in valuation. I’m optimistic that the poor performance in 2011 will lead to much stronger results in 2012. To ensure that I don’t end up suffering from the same human behavior related to New Year resolutions, I will have to ensure companies that have suffered permanent decrease in fair value are dropped quickly.
Thoughts on current holdings
Harvest Natural Resources: This is company that has yo-yo’ed between loved-hated-loved-hated. I think the company and the management team is at the ‘hated’ phase right now. Although self-labeled “value investors” are quick to change their mindset. The company sells at a huge discount to its Venezuela assets, Gabon discovery, and cash position. Plus the Indonesia drilling is still a game changer based on what management has seen in their first drilled well. I expect 2012 to be the year that management either sells certain assets or starts development plan for assets outside of Venezuela. I expect to likely sell out in 2012 based on what management decides to do.
Yukon-Nevada Gold: This company and management have gone from obsure to loved to hated to fraud to loved in a matter of 18 months. The company had a superb late-2010. Then in 2011 the problems started to show. Many hedge funds that had bought in 2010 bailed out and cashed in the quick 3-bagger. Others started to question management, and some even started to talk as-if the company was a fraud. All this while, the management team kept working on delivering on the plan set out in 2010. The company finally will have put in the plant upgrade to get production to a stable state of 150K oz of gold. I think the company’s stock will rebound to 2010 levels and should even surpass those levels. Investors that believed the 2010 plan put out by the management will be rewarded.
Bank of America Warrants: The most hated company in 2011. For value investors these are the type of companies you want to look at. And value investors were buying big. Major value investors (Buffett, Berkowitz, Pabrai, Chou) were buying BAC. I think this company is getting an incredibly bad rap from the media. The management team is doing a great job cleaning up previous management’s mess. The company’s operating business is very strong and the reserves keep improving each quarter. The legal issues surrounding BAC are the major uncertainty. We saw one major settlement in late-2011. I believe 2012 we will see many more cases get settled. These settlements should take some of the uncertainty away from this company. I expect the stock price to do very good in 2012.
Taro Pharma: This was one of the few stocks in 2011 that was a winner for me. It was up almost 50% within two months of holding the stock. The company will likely get bought out by Sun Pharma. The only question is at what price. Sun’s offer is at $24.50 and the market is pricing the stock at over $29. So the market is expecting Sun to raise its offer price. I think the fair value is atleast $40-50/share. Although given that Sun already owns over 60% of the equity, it is unlikely we get the $40-50 range. Although this could get dragged out for a while, as minority shareholders have said the offer price is too low. We will wait and see how it plays out.
Palladon Ventures: 2012 is the year this company starts production from its concentrate plant. In February the company should start producing from the new plant. The stock price has jumped quite a bit since my initial purchase. It is up almost 3x since my initial price. I expect 2012 to be the big year, with plenty more upside in 2012 and 2013. I expect this company to be a likely buyout candidate
Heckmann Corp: Heckmann had a very good 2011. The company finally started to get the revenue potential that I expected. The company will likely end Q4 w/ an EBIDTA range of around 13-15M per quarter. I expect 2012 to be a major year for the company. I think the company should be able to do 60-70M of EBIDTA. Also, I expect M&A to pick up in this space.
Reed Resources: This has been a mistake on my end. I bought the stock without thinking enough about the illiquidity. In 2011, I saw many opportunities to buy other businesses at much cheaper prices. Although I wasn’t able to jump on them because I couldn’t get out of the stock at a fair price. Although I would like to invest this capital elsewhere, I won’t get impatient and sell without regard to price.
Dolan Company: The company had a tough 2011. The main business, NDEX, struggled due to the slow-down in foreclosures. The US government took a long time to come out with the procedures that banks can follow. In Q4 2011 we finally started to see some uptick in foreclosure processing. I believe the NDEX business should perform very well in 2012. Also, many competitors had to close shop in 2011 as they couldn’t meet the new requirements or couldn’t survive the slowdown. The company’s other major business, eDiscovery, did very well in 2011. The management team did a great job in doing a small acquisition to grow the business. The business is growing very well and 2012 should show very good growth.
Harris Interactive: The new CEO has just started the turnaround. I expect to start seeing the results of the turnaround in the second-half of 2012. Although the first couple of quarters should see the drop in expenses and the company getting cash flow positive. Overall, I’m very optimistic about this company and the upside.
The “Green” revolution
Living in the San Francisco area, you tend to get exposed to many technological innovations before they become mainstream. It was about 9 or 10 years ago that I started to see signs of a cultural revolution towards “green” products. The initial attraction to these products was from individuals that were conscious of their impact on the environment. They wanted products that would allow them to enjoy the benefits of certain products while be aware of their decision would not have a negative impact on the environment.
I visited many local conferences focused on this “green” revolution. Viewing different offerings and “green” solutions, I realized there was a major disconnect between what customers were looking for and what was offered. Infact the products offered did meet the “green” requirements. Although there was something missing in these products.
A few years later, I read the book “Cradle by Cradle” by William McDonough and Michael Braungart. McDonough and Braungart are innovators in the “green” revolution. They have designed many products and processes for companies to produce products that incorporate the environmentalists approach. The book discusses the entire lifecycle of products, from the materials used in the products, to transporting the products, to after-life of the product. The authors argue that true “green” products need to consider all aspects of the product lifecycle inorder to create products that will have the least negative impact on the environment.
Looking at “green” products today, you will see the “green” label used as if it was just a sticker to be placed on any product. In the market you can find products that have no major difference between each other expect that one product sports the “green” label. Also most of the “green” products in the market have no real thought given to the entire process for creating the product and its after life.
So what does this green revolution have to do with investing.
The “value investor” label
Value investing has lately become a fashion statement. You can read any mutual fund’s prospectus and the fund manager will say his goal is to purchase companies that are selling for cheaper than its true value. The fund manager wants to buy stock in a company when it is selling for cheap and then sell it for a large profit. But we all know that majority of these investors never make any profit. Infact they clearly fail in purpose. The question is why?
One of my investment, Yukon-Nevada Gold, has provided me with an interesting view into this reason.
In late 2010 I came across a SumZero write-up by Jared Levin on Yukon-Nevada Gold (YNG). I read through the write-up and found it as a compelling investment opportunity. After researching it for a week, I had a talk w/ a hedge fund manager who runs a “value investment” centric fund. I mentioned YNG to him. A week later I talked with him again and he mentioned their fund was going to start building a position. A few days later, I saw the manager post a message on his blog about the company. In the write-up the manager said YNG had a book value of atleast 60 cents but was selling for 30 cents. The manager was also extremely bullish on the company’s future production potential and considered the investment in a gold producing company as a hedge against the macro economic concerns.
For people aware with the YNG story they know that YNG quickly moved from 30 cents to 90 cents. Just fast as it moved up, it quickly descended back to 20 cents. This fund manager sold out of their position at 60 cents.
With the stock price today at 28 cents and the book value still at a huge multiple to current price, a friend had a conversation with the same fund manager. Interesting, the fund manager’s reaction to YNG this time was that they were not interested. Although if you look at the valuation and the business fundamentals, today the company is much cheaper and less risky than in 2010.
So why did this so called “value investor” get interested in 2010 in YNG but then lost interest when the same opportunity came back a year later?
In fact, I’ve talked to many so-called “value investor” hedge-fund managers about YNG. A few of these fund managers are well known in the investing community. Some of these managers bought the stock in 2010 and then got out at the highs. When the opportunity presented itself again in 2011, these “value investors” didn’t want to touch it.
One of the rules of value investing is to separate the business from Mr. Market’s valuation. The market tries to capture the reality of a company’s business but many times the market makes mistakes in trying to reflect this reality. One of the reason is that the market is short-term focused and much quicker to react than the operating business. This means that certain companies that have a difficult short-term operating environment will have its stock price suffer. The investor that can look beyond the short-term pain can gain from this mis-pricing.
In 2010, as is today, the investment opportunity in YNG was based on stable production of atleast 120K oz. If the company was able to delivery on this then the valuation of YNG would be multiples of 30 cent. The fund manager that focused on the book value of 60 cents missed the entire investment opportunity. Book value doesn’t mean anything for mining companies. If you believed in the company and the management’s ability to get to 120k oz production then it was worth buying YNG.
This so-called “value investor”, similar to many other value-based hedge funds, have been using the value investing label to basically market themselves. Similar to the “green” product revolution, these hedge funds are like the “green” products that claim one thing but are actually shams when you look in detail.
More recently, another value investor wrote a letter to the management of Monument Mining about a recent transaction proposed by the management. The investor basically did a valuation of what the company is worth without the transaction and what it is worth after the transaction. Since the calculation produced a higher number without the transaction the investor concluded the transaction would destroy value. If investing was as easy as elementary algebra then we would all be rich. There is a huge distinction between an investor’s approach to the stock and the management’s approach towards running a successful company. It is only when you look at the company as an operation that will have an infinite life, then you can start understanding which decisions will create value.
In the last few years I haven’t been able to read as many books as I would like to. Although there are always some good books that leave an impact on you. In 2011, the books I would recommend are:
– The Small-Cap Advantage by Brian Bares: This was a book that I recently read in December. The book covers all aspects of starting and running an investment management business. It covers topics ranging from the right structure (hedge fund, IRA, mutual fund, …), to back-office and compliance, to marketing and raising capital. It is mainly focused on individuals that want to run a fund geared towards the small-cap investing. If you are looking to start a fund this is a great book. If you are something that is interested in small-cap investing, I highly recommend the first two chapters of this book. Small-cap investing has proven to beat the indexes over the long run. The book won’t help you find and screen for small-caps but it is rather focused on arguing that small-cap is a great place for investors will small amounts of investment assets.
– Mastery by George Burr Leonard: This book was written a while back. The topic of this book has grown in popularity over the years. In fact there are many great books recently written on this topic (Flow and Outliars comes to mind). Although this book has been exceptionally well written and can been used as a guide to start on your path to mastery in your chosen field.
– The Crowd by Gustave Le Bon: A classic for all human behavior students. A few years back I read this book for the first time. I enjoyed it immensely. I have now made it part of my list of books that is worth re-reading every year.
I haven’t been able to provide a detailed update on my holdings. Here is a quick update:
Q2 performance was bad for my portfolio. Almost all my holdings were hit and with a concentrated fund it can get ugly quick. Although I believe no one quarter is an indication of my analysis being right or wrong. For most of the companies that were hit hard, I was buying more in Q2. This further worsed the results in the short-run but I’m convinced in the long-run I will come out ahead.
I was adding position in HNR, HALL and HEK. I also sold out of BTC and GGP in the quarter. BTC is a turnaround play that is working out as planned, albeit I sold it to raise cash for other purchases. GGP has been an amazing return in a short period. It has been more than a 10-bagger (including HHC) in less than 2 years.
The last 2 weeks have been very interesting for the market and my holdings. The downgrade of US debt rating is a mind-boggling error from S&P. As Buffett said it “makes no sense”. The market’s reaction to this downgrade seems to makes even less sense. In no way does the downgrade of the US debt justify companies losing 10-20% of their market value in a few days. In most cases, the business prospects for companies does not change that dramatically in days.
I took the sell-off as an opportunity to buy companies that I know were selling cheap. The problem with the dramatic market decline is it didn’t provide much time to research new ideas. I had a cash balance of over 20% before the market decline. I used the sell-out to put half of the cash to work, buying companies like Berkshire and Goldman Sachs.
In Q1, I was up 7.25% compared to the S&P 500 that was up 5.42%.
This year is off to a great start. At a straight performance comparison the Q1 results might not look that spectacular. Although, looking at the individual holdings the performance was spectacular. For the quarter, I averaged around 16% of the assets in cash and was still able to beat the market. 8 of the holdings substantially outperformed the market (HNR was up 25%, ATS Corp up 64%, HEK up 30%, HHC up 30%). The two biggest holdings at the start of the quarter (GGP and Yukon-Nevada Gold) underperformed the market and had the biggest negative impact on the quarter’s performance. GGP was flat and YNG was down 22%. I believe on the long-run both of these companies will do well.
During the quarter, I was increasing my position in HEK, HNR and KVHI as the shares pulled back at the start of the quarter. I sold out of WCG and RSYS, to allocate the funds to other holdings and reduced my holding in GGP. I also built new positions in Dolan Company, Hallmark Financial, and Community Banker’s Trust. This quarter was quite busy for me, with the crisis in Middle East and tragedy in Japan created opportunities to buy companies that got cheaper even though they were not directly related to these events.
At the end of the quarter, I had cash accounting for 15% of the assets. There are a few companies that I’m currently looking into that could eat up some of the cash. Although I will keep a high cash balance, so it is more likely that I will cut my holding in other companies to build up new positions. Just after the quarter ended, I sold out of Avino Silver and bought more Hallmark Financial.
Thoughts on my holdings:
– Avino Silver: In the 4 months that I held the shares, the company was up 56%. I sold out after the quarter ended. There is plenty of upside still remaining, although I already have a decent exposure to commodities via YNG and Reed Resources.
– Reed Resources: The company is making progress around realizing value from its 3 main assets. The company announced changes to its profit sharing deal with Mineral Resources. Mineral Resources converted its 40% interest in the profits from the Mt. Marion assets into a 30% equity of a new entity, which will own 100% interest in the Mt. Marion assets. This is the first step in creating a structure which will allow Reed to spin-off/sell/partner on the Mt. Marion assets.
Also a recent research report puts a valuation of $1/share ($10 for each ADR share) for the company. I believe this to be a very conservative valuation and the upside could be much higher.
Below are my thoughts on some of my current holdings:
– ATS Corp: ATS Corp is basically a waiting game. We know the company has announced that it is pursuing strategic alternatives. We are just waiting for the details. In the meanwhile, the company keeps racking up big contract wins. The backlog is now at 1.3x the annual revenue run rate. Although I like this company and the near term catalyst, I might sell these shares incase other holdings get cheaper.
– KVH Industries: The company is setup for a monster 2011. In Q1, the company announced sales of its TracPhone v7 unit to a company w/ over 125 vessels. In late 2010, the company announced a major TracPhone v7 deal w/ the US Marine Corps. The company’s 2010 deal basically covers all the company’s costs for the airtime business. With the 2011 deal, the company’s incremental sales of TracPhone airtime would lead to mouth watering margins. The TracPhone airtime business has great operating leverage with additional revenue not requiring huge expenses. The installation of these TracPhone sales takes 6-9 months, so we won’t see the cash flow implications of these new deals until late 2011. I’m excited about KVH’s future prospects. I was buying shares early in Q1 as there was a pull-back in the shares.
– Harvest Natural Resources: Q1 was spectacular for HNR. In all aspects the company performed exceptionally good. The company reported huge increases in its Venezuela reserves, positive results from its Indonesia drilling, and a letter of intent signed with Transocean for drilling in Gabon. The company jumped over 10% in early March when it reported an operational update (discussing the reserves). The company announced the sale of its Utah assets for net cash of $205M. The company will use the cash to payoff the $60M debt and likely use the remaining cash to expedite the development of the Indonesia assets. Even with the jump in share prices, the company is still selling at a huge discount to the true value of the company. The next 3-5 months will be very interesting, I expect the company to either sell some of its assets or the entire company. I was buying shares early in the quarter as the shares were dropping for no apparent reason.
– Heckmann Corp: The company reported a good Q4 and raised projections for 2011. 2011 looks likely to be a huge year for the company, it will prove the company’s business model and setup the company for huge growth in the coming year. The company increased its FY’11 guidance drastically, increased revenue by 50% (from 100M to 150M) and EBIDTA by 100% (from 20M to 40M) (Yes, this business has good operating leverage). The company announced that in early 2011 the company acquired 1 company and is working on closing 4 more deals. These 5 deals are included in the projections for FY’11. The company is looking at more acquisitions and these future acquisitions are not included in the projections. My bet is the company will easily bet its projections. The company also bought back 1.5M shares. Overall, I think we are looking at a very strong 2011. I think we could see the company do 100M+ in EBIDTA in 2-3 yrs. Management has hinted that revenues could more than double each year in the near term (I think at least 4-5 yrs). Given the operating leverage, the upside is huge. One of the catalyst for Heckmann’s services is the pending Natural Gas Act, that is currently pending approval from Congress. I believe we should shortly see approval of this bill which should make way for diesel trucks to convert to LNG. This will create a huge demand for HEK services.
– Yukon-Nevada Gold: Gold prices are at all time highs. The company has an cost of production of $600/oz compared to gold prices of $1,300. The company should be able to produce 140oz per year. Although the company reports extremely poor production numbers. Why? Its the weather. Sounds like the ‘dog eat my homework’ excuse. As bad as it sounds, YNG has been severely impacted by bad weather and poor preparation to handle the conditions. YNG recently announced expedited conversation of warrants at 18% discount to conversion price. I think management made a smart move by taking a hit on the cash proceeds, allowing the company to be prepared for the next winter. In turnarounds you are bound to have road blocks. I think the company is still on track for some amazing growth in production for the next 5 yrs. The shares took a hit in Q1 but I think this is only temporary. The company expects to produce around 400oz of gold in couple of years. Management has said they expect to hit 1M oz of production by 2015, so the upside on this is huge.
– General Growth Properties: GGP had its first conference call post-bankruptcy. The company provided no specific guidance. Although listening to the management’s plan it is clear that GGP has a strong future ahead. In the next 12 months we should see the company recapitalize large chunks of its debt (already they have the longest maturity of all REITs), shed non-core assets, invest in core assets, and negotiate better lease rates. In the long run, the company has mentioned plans to expand outside US (I think it is Asia, Canada, and Brazil) and I could see them acquiring strong assets in US. Although the shares have run up substantially since my initial purchase, I still see no reason to sell. The only reason I would consider selling is if I need cash for new purchases, as I did late in the quarter. I sold 30% of my holding. GGP still is my largest holding.
– Hallmark Financial: The Q4 numbers were bad. The bad winter that hit most of US had a big impact on Hallmark. I work for a P&C Insurance company, so I was aware of the impact the bad weather had on my company and most insurance companies. Although I believe the shares sell for a decent discount to book value and there is plenty of growth opportunity w/ a very good management team at the helm.
– Community Bankers’ Trust: This is a new buy. The company is a small bank that is selling for a big discount to book value and is a turnaround play. I have been watching this company for many months now. The biggest problem for the company was the management was not executing and seemed very reluctant to take steps to turn the company around. In the last few months the BoD has replaced the CEO, added new members to the Board, sold off some assets, and started to increase fees for services. The shares of the company dropped from $3 to $.77, management was buying shares at each dip. There have been no insider sales. And finally the company’s performance is starting to turnaround.
– Palladon Ventures: The company signed up two major customers to purchase its iron ore. The customer invested cash in the company, allowing the company to build out its concentrator plant. Once the plant is built, in 2012, the company should be processing 2M tons per year. In the meanwhile the company is going to sell its run of mill product to generate decent cash.
I ended the quarter w/ cash making up 15% of funds. I like to have a cash balance much higher, so I will likely be building up cash in the next couple of quarters as some of my ideas work out.
With the run up in the market in the last 6 months, I’m not finding many investment opportunities. I’m finding plenty of turnaround situations but most turnarounds are unlikely to be successful so I have been staying away from them. The investment opportunities that I have found (Dolan Company and Hallmark) will likely become more concentrated positions.
As I review my portfolio, I realize that in the last few months I’ve gotten away from my emphasis on a concentrated portfolio. A portfolio with 12-15 investments would be considered concentrated by most folks. Although when I’m managing my personal funds and there is no outside pressure on the liquidity requirements, I would like to see a much higher concentration. When you look at what Buffett did in his early days, he would be holding 4-5 investments.
As I look at my current holdings, if I had concentrated my investment in the top 7-8 ideas the returns would have been much better. Also, I would have been more focused on the companies and be able to research them in further detail. I will likely start getting out my least favorite holdings and concentrating further in my top holdings.
For the fourth quarter, the portfolio returned 10.22%. The S&P 500 index returned 10.76% for the same period. for the quarter my return was handicapped by the poor performance by my biggest holding (CPD, which was down over 15% for the quarter).
For the FY2010, the portfolio returned 8.85%. The S&P 500 index returned 15.05% for the same period. Again, the biggest drag on the results was the poor performance of my largest holding (CPD, which was down over 23% for the year).
Since 2009, the portfolio has returned over 149% compared to the S&P 500’s return of 39.2%. I’m still working on putting together the historical performance. I plan on posting that fairly soon.
Thoughts on our holdings:
Caraco: This was our biggest holding and 2010 was not a good year for CPD. For the year, the company was down over 23% in 2010. The turnaround for the company took longer than I expected. In December, Sun Pharma made a low ball offer to take the company private. Then the news came that the distribution deal between Sun and CPD would expire in 2012. It was this news that led me to sell out of CPD. I believe CPD was doing around $300M of revenue prior to the FDA issues, with only $50M from drugs manufactured by CPD. The rest was coming from the distribution deal. Once the distribution deal expires in 2012 and the limited manufacturing from its Detroit facility, I believe CPD will be burning cash without the distribution revenues. In the meanwhile, the verdict on the Sun Pharma offer should be coming shortly. At $4.75 per share, I think it is a steal. Although I don’t have confidence in the independent board members and the valuation from a third-party. In early January I sold off most of my holding. As of today, I have completely sold out of my holding.
Harvest Natural Resources: The company did a major financing deal in late 2010. The company has started drilling in Indonesia. I expect the results in the next month. In the meanwhile, the company keeps developing its Utah assets. In January the shares have taken a hit, I have been adding more with the pullback.
WellCare: In December we finally got news that the company will be providing service to two additional counties in Florida. It has been years since the company has be able to expand again in Florida. I believe the company is a likely acquisition candidate.
General Growth Properties: 2010 was a big year for the company. The company emerged from Chp 11 with the backing of BAM/Ackmann/Berkowitz/Blackrock. 2011 should be a big year for the company, as well. The company should complete refinancing at much better terms, expand outside of US, and shed low performing assets.
ATS Corp: We bought ATS in late December. It was selling at a huge discount to cash flow and had strong growth prospects. Only few weeks later, the company announced plans to pursue strategic alternative, likely selling itself. I expect the company to announce something in next couple of months.
Yukon Nevada Gold: The company has a huge 2010. We ended with over 150% return in less than 6 months. I believe the turnaround of this company is still in process and there is plenty of upside still remaining. In the most recent corporate presentation, the company expects to hit 1M oz of annual production in 5 yrs, compared to the current 120k of annual production.
Howard Hughes Corp: The company ended the year with a new management team and some initial steps at starting development at some of its properties. This investment will take a while to materialize, although I expect the wait will be well worth it.
KVH Industries: The company had a strong 2010. The huge contract with the US Coast Guard. I expect 2011 to be a breakout year for the company. We should see the strong cash flow generation from its VStat business.
Palladon Ventures: 2010 was a big turnaround year for the company. The company successfully shipped its first shipment. The company also lined up the agreements to transfer its iron ore from Utah to the ports in Richmond, CA. Also, the company has successfully raised capital for its production of concentrate ore and expand production. In 2011, the company will increase its shipment of iron ore to its Chinese customer.
Avino Silver: This investment has been a play on the silver prices. I expect the company to substantially benefit from any rise in silver prices.
Heckmann Corp: The company had a very good 2010. The acquisition of the CVR will have a huge impact on the company’s 2011 performance. I expect the future for this company is exceptionally strong and with the $200M of cash on hand, the company should be able to put the capital to grow and become a monster it the water business.
I ended the year with 10% of the portfolio in cash. In January, we sold out of our holding in CPD. The cash position as of today is roughly 25%. The cash holding is likely to stay high, for some opportunistic investment opportunity (like the pull back I’m seeing in HNR).