Portfolio Review

2019 has been a fruitful year for the portfolio so far.

In 1Q19, the portfolio returned 17.69%, versus 10.51% for the MSCI ACWI ex-US, and 9.16% for the DAX.

Year-to-date, the portfolio has returned 23.22%, versus 11.84% for the MSCI ACWI ex-US and 16.60% for the DAX.

The careful and strategic choice to operate a concentrated portfolio of very idiosyncratic return streams usually allows one to surf a value cycle to these returns.

The top 3 holdings correspond to over half of the portfolio.

1. Ferrari = 24%
2. Nilörngruppen = 16%
3. Ashmore = 15%

Clearly, my aim is not to follow indexes. As I explained in my Investing Blueprint, published in a prior post,  I believe in an unconventional approach that is patient, concentrated and rigorously research-driven. . The distinctive nature of my holdings means that at times the portfolio will suffer from intense periods of underperformance (just like in 4Q18). However, over the long-term, the margin of safety and value proposition of each investment should protect and compound the portfolio’s future returns.

I discuss below all the holdings in the portfolio in more detail. The order is based on position size.

Please note, though, that portfolio holdings are subject to change and holdings discussions are not recommendations to buy or sell any security. Current and future holdings are subject to risk. Please do your own research.  

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Ferrari:

Ferrari was the largest position of my portfolio and it has performed well.

The investment in Ferrari was an opportunity to benefit from how the market was miscategorising, and thus mis-valuing, the company. Ferrari is seen as an automobile manufacturer, when in fact, that’s only one part of the company. Ferrari is more than that – it is a luxury brand with heritage. Ferrari’s brand commands tremendous pricing power which allows it to withstand market drawdowns and even recession at a much better rate than most companies (its revenues were up over 7% during the recession of 2007-09, unlike any other global auto manufacturer). There are very few assets that appreciate in value over time (and especially rare when discussing cars), and fewer yet that have queues with overflowing, price-inelastic demand. Any assets that display these characteristics are no-brainers from an investment point of view. Ferrari is a true high-quality asset. One that creates value for customers – by allowing them part of the exclusive club and pay for the privilege through their patronage of its products (as around two thirds its of cars are sold to repeat buyers) – as well as to shareholders, who profit from the company’s powerful and durable brand that generate the high incremental margins and returns of capital that have catapulted Ferrari’s stock price and made the company into a true compounder.

The question was never whether to buy Ferrari, but when to buy it. Investors buying Ferrari around the €60s, or even €90s (prices at which I bought my shares) were definitely not paying much for growth opportunities. Asia, China especially, remain largely untapped.

On top of that, having Ferrari in one’s portfolio serves as a gateway to capital preservation. At the prices purchased, the investment in Ferrari is as much of a growth one as it is a defensive one.

Ferrari ended up being a quintessential value investment. Undoubtedly fantastic products with limited risk to disruption; abundant growth opportunities (as Asia, China especially, remain largely untapped); significant downside protection; and with a very capable and aligned management team behind a very clear strategy.

 

Nilörngruppen:

The origination of this idea comes from the idea that Nilorn’s products (customized tags, labels and packaging for clothing retailers and brands) was a necessitywithin the industry’s supply chain. Most apparel manufacturers buy the cheapest labels they can, but in a world with increasing numbers of clothing brands, differentiation has become a necessity. Nilorn targets this subset of customers who are willing to pay a little extra for an idiosyncratic design.

Nilorn is integrated into its customers’ supply chains, because customers cannot sell clothes without labels. By selling a relatively inexpensive but critical component for its customers’ businesses, Nilorn creates a captive customer base with sticky revenue.

The numbers show that business has been good, given the 5-year average sales growth rate of 16%, 30+% average ROCE and 40+% average ROE.

Despite the fact that Nilorn is not the consolidator, there is much market share to gain. Customers trust smaller – albeit big enough to have the design and logistics infrastructure necessary – players to deliver quality value-add to their brands. My analysis suggests that Nilorn is one of these market share gainers, and at FCF yield of 11%, Nilorn seemed like a great investment opportunity.

Nonetheless, not much has happened so far. From my average purchase price of SEK 78, the share hasn’t moved much. The idea was that the listing on Stockholm’s main stock market would bring more visibility into the quality of the company and its growth rate, and that its generous dividend yield of >5% would attract investors. However, I think this stock has been suffering because of some insider selling and its low liquidity. But for a typical value investment like this – highly protected thanks to a low valuation and conservative balance sheet, while investors aren’t paying for the growth that the company can engage in – Nilorn’s stock should get some more attention as the company continues to execute, or even, goes back into its acquisitions strategy, which I believe it has the ability to capitalize on. I guess more patience is needed for this idea to pan out.

 

Ashmore Group:

Ashmore is a UK-based investment management firm focused on the emerging markets, with close to 90% of AUMs tied to fixed income.

The investment thesis for Ashmore was the following:

• The company’s culture is enviable, and management is seriously aligned. CEO Mark Coombs, who owns around 40% and sits on the trading desk.
• Emerging markets represent 85% of the world’s population, 60% of global GDP, and 32% of global consumption. Yet EM have less than 25% market share of the global financial and debt markets, even though their debt-to-GDP levels are way below that of developed markets. EM are well positioned to deliver above-average growth going forward, evidenced by the fact that allocators are putting more capital into EM assets. But why Ashmore specifically? Well…
• Ashmore serves as strategic exposure to EM with limited risk, diversified by their operations and listing in the UK. By benefiting from Brexit, and thus Mr. Market price gyrations, I was able to purchase Ashmore at around a 9% FCF yield, which for a company that maintains such a strong balance sheet, with over £650 million in cash and no debt, was a bargain. Additional safety was provided by the stable 4% dividend yield that the company pays, even though emerging markets are quite volatile.

Altogether, it seemed like a great opportunity – one that was, in my mind, noticeably mispriced and had the perfect elements in place for the share to re-rate. This investment has paid off handsomely to date, and I still believe it has room to grow.

 

Ocado Group:

As expected, Ocado was a growth play. The difference for me was the fact that the company has no direct comparable, which means it is miscategorized, and thus, often misunderstood.

On top of that, the bear thesis around Ocado was so aggressive that it made it clear to me how mispriced this opportunity was. Bears kept labelling Ocado as the “Microsoft of Retail”, a retail/grocer being valued as a software company. And kept attacking the astronomically high P/E ratio. Fair enough. But to me, after doing my research, I felt like the market was missing the forest from the trees.

And interestingly – I had studied and invested in Ocado before. I held it for about a 15% return, then sold it after learning about Amazon’s acquisition of Wholefoods, which I believed would put pressure on Ocado’s success in the UK. I had made the mistake once, so I believe I was better prepared this time.

To me, the best way to think about Ocado as an investment is to focus on the underlying themes here, which are digitalization and disintermediation. These connect to the scalability potential of Ocado in forming partnerships that have, and I believe will continue to, propel the stock upwards.

Through automation and robotics, Ocado eliminated the inefficiency that most supermarkets go through when they have to send workers out to pick individual online orders off the shelves. This is evident by the fact that Ocado has been benefiting massively from the shift to e-commerce, and the growth has been pronounced.

So, despite the high multiple, an investment on Ocado made given the quality of the business and the catalysts driven by the new partnerships that the company negotiated. My analysis suggested that Ocado has the leading customer proposition in the British grocery sector, which coupled with the company’s scalability, would earning a high cash flow multiple in the long-term.

It has since paid off. I recently sold my position with over a 55% return, as I was seeing other opportunities with a wider margin of safety. Although I still believe Ocado is a high-quality company with a great long-term proposition, led by a best-in-class team.

Interestingly, with the current price drop, I’m once again studying the company. It might present a great time for investor to re-enter this compounding investment.

 

Piaggio & C:

Piaggio is a competitively advantaged firm engaged in the production of two-, three- and four-wheel motor vehicles. The company operates in a complicated industry where long product cycles and deep capital outlays make FCF visibility quite uncertain. Nevertheless, Piaggio has been showing very positive results this year.

The thesis back when I first bought the stock was based on contrarianism and pricing power. Piaggio is quoted in Italy, which at the time was the lowest and most hated index in the world, with its biggest markets being Italy, France and Spain, all suffering economically. On top of that, the stock was punished by the auto sector capital cycle. However, Piaggio managed to sustain these obstacles thanks to the pricing power of its strong Vespa brand and overall high-quality and durable products, all managed by a strategically astute owner-operator, Roberto Colaninno, with fantastic capital allocation skills.

At the time of purchase, around September 2018, Piaggio was attractive even without pricing in growth. Thanks to its operating leverage, any recovery in their main markets would have a huge impact on their EBITDA margins. So, when I looked at the growth potential in Asia, Piaggio was even more attractive. Firstly, in regards to India, Piaggio has an advantageous position in the Indian rickshaw market, and just began introducing their two-wheeled products to the region. And secondly, Piaggio has almost no market share in China, so any market share that the company gains in that region would have a huge effect on total sales.

With an upside-to-downside ration of over 4-to-1, an investment in Piaggio was a no-brainer. As of 1Q19, Piaggio returned 8.7%, and YTD, it has returned 24.3%. I still think there’s more to go.

 

Naspers:

Naspers is a South African holding company with a portfolio of media and technology businesses, but its crown jewel asset is a large ownership stake in Tencent. This is where we find the rationale for the investment.

One of the best things about internet businesses is scalability, and the market ends up paying high multiples for this scalability if executed consistently. Tencent fits just that mold. Tencent is a strategically sound company operating in a gargantuan and growing segment of the technology sector.

Its main applications like WeChat, QQ and Qzone (among many others) are social media platforms with great scaling potential, relentlessly dominating the growing domestic market in China. Not to mention, WeChat Pay is one of the two largest mobile payments platforms in the world, and Tencent owns media subscription services with over 100 million subscribers, video game publishers that are highly cash generative, have high margins and generate high ROIC, and has a meaningful e-commerce exposure through their shareholding stake of the famed JD.com. Tencent will be one of those companies that will end up owning the internet.

As of 1Q19, Naspers returned 20.73%, and YTD, it has returned 32.43%. I had bought the stock when, based on my analysis, it was trading at >35% discount to my estimates of intrinsic value. I still see nowhere for Tencent – and consequently, Naspers – to go to but up.

 

The Restaurant Group:

I think TRG was my biggest mistake. Fortunately, I sized the position small – the rationale was because of the negative Brexit sentiment. The problem with Brexit is the UK consumer, and thus, the first sector to feel the punch would be leisure and retail – restaurants and high street.

My underlying thesis for investing in TRG was the following: The company was highly cash generative, with a strong balance sheet and healthy cash position, and location/scale advantages. I saw opportunity in these hated sectors, as prices were, in my opinion, unjustifiably low.

At the time, I was in between investing in either TRG or Dixons at the time (Baupost Group had invested in the latter according to a FT article). I ended up choosing TRG for the resilience it had shown in the past, and the consistent returns on capital it had generated. I thought TRG was different from other restaurant companies, as the Group enjoys a diversified portfolio of high-quality assets with domestic focus that are highly cash-generative, and behind all of that lies a hidden asset, which is the Group’s pubs and concessions businesses. Therefore, investing in a company with an average ROCE of 18%, strong balance sheet, comfortable growth avenues, an undemanding valuation (forward FCF yield of 10.6% in late August 2018) seemed like a no-brainer.

Well it clearly hasn’t been a successful judgment call so far.

Nevertheless, I still believe in the company’s local advantages, and the growth hidden behind their concession business, as well as behind their Wagamama purchase, which I believe has been excessively punished by the market. I have been to most restaurants of the Group (mainly F&B, Garfunkels, Chiquito and now, Wagamama), and from these, I have tried almost every item on their menus over the past 8 months. It has certainly been a ride, but I still think the market is being short-sighted on TRG’s intrinsic value.

Anyway, I can’t deny that this has been a major analytical mistake to learn from.

 

Noble Group:

The Noble case was my one true speculative trade. As such, it was a small position in my portfolio, but an important mistake to investigate.

My thesis was based on the company’s ability to restructure its debt. However, Noble’s restructuring was daunting in terms of its scale, urgency and complexity. Naturally, the share was a roller-coaster. Amid restructuring negotiations, the volatility tested my temperament. But, my analysis – which incorporate financial and political research – dictated that this was an asset valuation play, and that the risk/reward was in my favor. Unfortunately, that ended up not being the case, causing a loss of over 35% to my position.

My biggest mistake here was analytical. I didn’t engage in deep financial analysis – that’s why it was a small position, but perhaps, that’s also why I made the mistake in the first place. I did read Iceberg Research reports, as well as other write-ups on Noble, but didn’t do the deep individual research work I’m used to performing with other investments.

We all [think we] know that we should never gamble when embarking into the endeavor of investing. But it’s a different feeling when you actually make the mistake yourself and take a loss. It then becomes an internalized lesson – one which I will always check so that it doesn’t repeat itself.