Taking Stock
As of October 31, the Value Fund was up 16.6% in 2013 and 20.5% over the past 12 months (both figures are after all fees and expenses). Since inception we have had 20 positive months and 4 down months. Given that GreensKeeper recently celebrated it second anniversary and with a new calendar year fast approaching, we thought that it was the perfect time to revisit a few of our portfolio holdings, discuss a stock that we recently sold and to take a look at current market valuations.
We first wrote about Home Capital in the Globe & Mail on August 8, 2012. Since then the company has done what it usually does – execute on its business plan and increase earnings per share at a steady pace. We estimate that the company will earn about $7.30 per share in 2013 and at least $8.30 in 2014. A favourable regulatory ruling last quarter will also provide a tailwind for years to come. Despite the company’s consistent execution, its stock has been anything but consistent.
The pullback in Home Capital this past spring was largely the result of a speech given by Steve Eisman, a U.S. hedge fund manager, at the Ira Sohn investment conference in New York. Mr. Eisman recommended that investors short Home Capital’s stock given his view that the Canadian real estate market is overvalued (we agree) and that Home Capital is a “sub‐prime” lender. Here is what we wrote to our clients back in May:
“We continue to believe that Home Capital is misunderstood, particularly by our friends south of the border who recently lived through the U.S. subprime housing debacle. Home Capital is an excellent lender. They do not make “no doc” (undocumented income) or “NINJA” (no income, no job, no asset) loans and their average loan has about 30% homeowner’s equity behind them…. At current prices the stock is trading at approximately 7.3x 2013 earnings. We used the pullback as an opportunity to add to our position and believe that in time the stock will trade at materially higher levels.”
Our patience has been rewarded as Mr. Market is now awarding the company a reasonable price to earnings multiple. We remain vigilant as the Canadian housing market is not cheap by any means and Home Capital’s shift to its more profitable “traditional” loans has had the effect of increasing the company’s exposure to a major housing correction. But with a short position in the stock last reported at around 12% of the company’s float, a short squeeze is a real possibility.
With the stock currently trading at less than 10 times next year’s earnings, and the shorts feeling some real pain, we are still comfortable owning the stock. Our cost base of $48.83 (+70%) and the company’s habit of frequently increasing their dividend also makes the stock an easy one to hang on to.
Home Capital is a “compounder” and one worth holding on to for a long time absent more attractive places to put our capital or a change in our view of the company’s business.
Our thanks go out to Home Capital’s CEO ‐ Gerry Soloway and President ‐ Martin Reid for their exceptional execution and shareholder‐friendly stewardship.
Western Union (NYSE:WU)
Western Union (NYSE:WU) reported decent Q3 results in late October but management’s guidance was troubling and caused us to reassess our view of the company. Western Union is facing increasing compliance costs and is slowing its pace of share repurchases in order to preserve its investment‐grade credit rating. We decided to sell our position after digesting this news. Western Union is a good company but not a long‐term grower like Home Capital. With our purchase price of $12.54 we exited with a healthy profit (+28%). Our one regret was not selling before the quarter. Had we done so, our results would have been even better.
Our Dogs
The Value Fund’s worst performing holding to date is … cash. That’s right, cash. In this low interest rate environment it just sits there, growing nominally and begging us to deploy it. As new clients arrive at GreensKeeper, we seek to reinvest the additional cash but many of our holdings have become less attractive due to their price appreciation. As a result, our cash position steadily builds. In the midst of a rising bull market it has been painful to drag this anchor around. We continue to seek a better home for our cash but the reality remains that we are very picky. Our preservation of capital mindset means that we want to be very confident that the opportunities that we invest in are attractive. While this approach lets us (and hopefully our clients) sleep soundly at night, it has the unfortunate side effect of causing us to miss a few opportunities along the way. On several occasions since our launch we hesitated to purchase a stock, waiting for a more attractive entry point. Unfortunately our occasional hesitation has cost us some performance.
We can confidently make two promises to our clients. First, we will continue to make a few mistakes (hopefully they will mostly be errors of omission). Second, we will continue to learn from them. One of the great things about investing is the perpetual improvement that comes with age and incremental experience.
There are a few positives to carrying a cash position. First, holding some cash gives us optionality. In other words, when attractive opportunities present themselves, we can pounce. Second, the fact that cash has been our worst performer also means that every stock that we did purchase is up. Some (Home Capital and Western Union) more than others (Joy Global).
Joy Global (NYSE:JOY)
We first wrote about our investment in mining equipment maker Joy Global in October 2012 (1). The company derives roughly two‐thirds of its sales from coal‐mining customers and the troubled state of the coal industry, particularly in the U.S., is weighing on the stock.
Coal is a dirty word these days and some wag even labeled it the “new tobacco”. The Province of Ontario recently introduced a plan to ban all coal use in its power plants. Pictures of smog‐shrouded Chinese cities are carried daily in the news. President Obama, through the Environmental Protection Agency, is curtailing the use of coal south of the border as well. These headwinds, along with slow economic growth across the globe have weighed on coal prices and, naturally, coal mining.
While we can debate the wisdom of North American energy policy, the reality is that we can afford to make decisions that favour the environment over the economy. Canada and the U.S. are wealthy nations. We can afford these trade‐offs, even if certain policies may be ill‐advised.
At GreensKeeper, we believe that emerging economies such as China will make different choices. And it is emerging economies that truly matter when it comes to coal. China alone consumes approximately 50% of the world’s coal (it is four times the size of the US coal market). Coal is cheap, abundant and a reliable source of energy. It is used to generate 30% of the world’s primary energy needs. As China’s rise continues, its economy will require more and more energy to fuel its growth. India and other developing countries are no different. Like it or not, we believe that King Coal is here to stay.
As one‐half of a coal‐mining equipment duopoly (with Caterpillar’s Bucyrus division being the other half), Joy Global should continue to increase its earnings over the coming years, even if the road will not be a smooth one. And that, in a nutshell, is our investment thesis on Joy Global.
Our investment in Joy Global has been essentially flat (+4%) since we started purchasing the stock about a year ago. This is a disappointing result given the broader market’s upward march over this period. Nevertheless, we remain long‐term bullish on the name and are comfortable owning it in our portfolio.
Minding Mr. Market
Long time readers already know that we don’t try and time the market at GreensKeeper. We will deploy capital any time that an attractive opportunity presents itself, regardless of market conditions or the state of the economy.
However, we do follow macroeconomic trends and general market valuations to provide useful context when evaluating specific companies and industries. The pictures at right speak louder than words.
These stock barometers, technology IPO valuations and our current struggle to find attractive opportunities are all telling us the same thing. At present, it is probably better to be more fearful than greedy.
Michael McCloskey
Founder & President