Portfolio and blog situation update Q1/2017

It’s three months since I last posted so I thought I will make small update on how I and my portfolio is doing, and to tell that the lights in this blog are still on, although apparantely less often.

My posting frequency has come down radically for two reasons; first, I haven’t had good new investment ideas to write about, and second, I have a new job so I haven’t had time to seek them.

On portfolio front my current composition is as follows:

I know, it’s not very well lined up but it is what it is. Let me explain.

Cash

Biggest position is cash (42,6%), of which I’m not too happy about. Explanation is that I have been selling shares  as they have reached their fair values.

From expected value point of view it would make sense to hold fairly valued shares rather than cash but I have tried to keep strict selling discipline on stuff I wouldn’t buy to keep myself working on new ideas.

But 40%+ cash position has forced me to reassess the policy because I want more or less 100% market exposure at all times and 40% cash means that the work has not been productive.

I haven’t decided yet what I will do with the cash, but starting monthly saving to index funds has been on the table. No rushing though.

Martela

Second largest position is Martela (24%), which is one of the biggest office furniture companies in the Nordics.

Martela has net cash and it trades under 10xEBIT after tax and my thesis is twofold.

Firstly, the company’s goal is to increase concern level operating margin from 4% to 8%, which seems to be achievable because;

a) Martela’s Finnish segment was doing already 8,5% in 2015 when most of the savings programs weren’t materialized, and there is no apparent reason why it couldn’t be achieved in the International segment

b) Martela’s costs have come down significantly in last two years after restructuring and management’s goal is to continue on the same trend this year

c) Martela seems to have good operational momentum as new products have been released, marketing updated and organization renewed and it could continue for some time

If the margin expansion will materialize Martela’s profits will double and with the low multiple so should the stock price.

Secondly, market seems to be recovering from almost 10 year recession, which could boost cyclical office furniture sales and thus Martela’s earnings.

Same time, if the economy doesn’t recover or the margins expand current valuation seems about right which offers some margin of safety.

Position is outsized but given my cash position my portfolio level variance is probably still acceptable. I have been reluctant to sell, although I have sold some (about 5% points from peak 30% exposure), because I still see the risk-reward attractive.

Ferronordic Machines

Third largest position is Ferronordic Machines preference share (13,1%), which is perhaps my favorite position in terms of underlying business. It sells construction equipment in Russia and is the largest player there.

Despite collapse in the construction equipment market (-80% from the peak) Ferronordic’s earnings have grown, both in western and in local currency, which I consider extraordinary achievement given the difficult environment and sign of business quality.

In Q3 management saw first signs of recovery and confirmed the observation in Q4, which suggests that the Russian construction equipment market has bottomed.

With a 970 SEK/share market price and a 110 SEK the dividend yield is okayish 11% (for Russian exposure) but what makes it attractive is the growing dividend and conversion option to common stock if the common stock is IPOed anytime in the future.

The dividend increases by 10 SEK/share for every year Ferronordic delays the IPO which implies attractive 9% (initial) dividend growth rate.

The conversion option is technically a 1300 SEK conversion claim inherent in the preference share, which basically means that it can be used as currency for buying the common stock in the possible IPO. The 970 SEK market price for the preference share implies that the market price is 73% of the conversion claim value.

With the 11,5%+ initial dividend yield, 9% dividend growth and 36% upside to the conversion claim value potential return from holding the preference shares seems satisfactory. My plan is to collect the (well covered) dividends while waiting for converting the shares in the IPO.

With consistently high ROE and favorable long term prospects I could perceive myself holding Ferronordic’s common stock even after the possible IPO conversion, if and whenever it happens.

Installux

Third largest position (7,7%) is Installux which is highest quality business in my portfolio. My thesis is that the Company has switching cost competitive advantage, very profitable business, stable earnings and favorable prospects due to the French construction market recovery.

Since my first writeup management has “confirmed” that the market turnaround they were expecting is real so the thesis is moving to right direction.

The company’s net cash is 25 MEUR and market cap 126 MEUR, so the operations go for about 100 MEUR. Earnings are about 9 MEUR, so ex. cash PER doesn’t seem outrageous given the quality of the business (20%+ ROIC at all times) and growth prospects from recovering market.

If the price stays at current levels my plan is to hold the shares.

Argo Group

Fourth largest position is Argo Group Limited, a small emerging market hedge fund manager.

I bought it in 2013 for approximately same price it’s trading currently so the opportunity cost relative to other investment has been huge.

Original thesis was that it was profitable business selling significantly below NAV which was essentially cash and investments in their own funds.

Soon it became clear that the funds had huge concentrated positions in illiquid non-operative Indonesian oil refinery and Romanian and Ukranian real estate assets, making the fund valuations in the balance sheet uncertain.

Further, cash flow turned negative as it was impossible to collect management fees from the illiquid assets base. Management fee receivables and loans given for the funds to finance their immediate operational cash needs were written down as accounting rules deemed them “uncollectible”.

Stock price halved, despite management’s reassuring that eventually the illiquid assets would be sold and management fee and loan receivables fully collected.

Despite 50% loss on original purchase price at the time I decided to hold my shares because I chose to believe the management’s reassuring and because adjusted for the written down management fees and loan receivables NAV exceeded the stock price by almost 300%.

Towards end of 2015 Argo announced that they had sold the Indonesian refinery asset and that the related management and loan fee receivables will be collected, and thus most of the uncertainty relating to the balance sheet values was cleared.

Long story short, with the improved liquidity and low stock price Argo announced stock buyback program, which cut the outstanding shares by third and increased reported NAV/share by 50% and the stock price doubled from the lows to the present (and my original purchase) price.

In the latest annual report Argo had 22 MUSD reported book value vs. 9 MUSD current market cap, so the upside to latest NAV is about 130%.

My thesis is that

a) now most of the illiquid assets in the funds have been sold and proceeds reinvested to liquid emerging market bonds

b) lot of the uncollected receivables collected

c) management has started to relaunch the business (hired new analyst and IR-professional, updated to new fund mandates) and gather new funds after solving most of the old problems,

the business is selling significantly below liquidation value (i.e. below net cash and investments value), which is too low.

Elverket Vallentuna

Last position is Elverket Vallentuna with 4,8% position. Elverket is regulated electricity network monopoly in Sweden. This was my largest position at some point (16% at the time of my first writeup and probably 20% at its peak). I have been selling the shares since as the stock price has increased.

My thesis was that, as result of ruling in court order over electricity distribution prices, Elverket Vallentuna had billed too little from its customers in prior years, a deficit which could be thought as extra cash.

Cancelling the deficit (70 MSEK), net cash (30 MSEK), and potential reduction in extraordinarily high receivables (140-170 days or 30 MSEK too much) from the market cap at the time (270 MSEK) meant that one was paying very little (140-170 MSEK) of the underlying operating business which was worth a lot (at least 400 MSEK).

Currently the market cap is about 500 MSEK, so I don’t see that much upside anymore, per the valuation sheet below:

There has been some positive developments at the network market as, after another court fight over electricity distribution prices, the networks are allowed to charge in 2016-2019 regulatory period more than was originally decided.

My valuation sheet reflects these developments by putting more or less arbitrary premium valuation  (450 MSEK) on the networks current regulated asset base (340 MSEK).

As the market cap reflects my perception of fair value value I will be selling rest of my shares when I’m in the mood next time.

Sold positions

I have also written about Kotipizza and Catella but which I have sold. Kotipizza was “growth at reasonable price” case and Catella “complex sum of parts” case.

I sold Kotipizza because the stock price moved up significantly and the earnings multiple rose to 17-24, depending on do you use forward or trailing earnings as the calculation base.

Kotipizza’s growth has been strong (latest system sales growth 18%) for two years on back of new concept rollout under private equity management and there is no sign of slowing down but as “value investor” I bailed out on the elevated multiple before the signs appear and as I didn’t have strong opinion how long the growth could continue (originally I bought the shares on earnings multiple that assumed no or very little growth).

Recently Kotipizza has started to market its own phone pizza delivery app, which have been game changer events internationally. People purchase more often with the apps as ordering is so easy and average checks are higher as they order more to justify the delivery charge.

International evidence suggests that Kotipizza’s growth might still have some legs as the trend is essentially just starting. So I have started to doubt if I jumped out too early, especially because my replacement “investment” was cash.

I also sold Catella, a complex Swedish (small cap) financial conglomerate  because their most important business line, the Mutual Fund business, has had significant fund outflows for many quarters in a row and because there was significant decrease in earnings belonging to the parent company’s shareholders.

With 14x on declining earnings (10x if one uses adjusted net cash), I didn’t like the price anymore. More over, for long time it was kind of half idea and I was lucky on the idea because the business grew on the back of strong stock and real estate market, which was not part of my original thesis back in 2013.

Conclusion

Conclusion is that my portfolio has too much cash and I have no new stock ideas.

I started the blog about 2 years ago with “Cheapest stock of the week” -series, which included random writeups on cheapest stocks I stumbled on every week. Slowly, I moved to writing on ideas that I owned and thought  are worth buying because I only wanted to publish “the good stuff”.

In recent months I have written of neither one, the good nor the bad ones. Then, recently I stumbled on this post on excellent blog called Reminiscences of a Stockblogger, which said something what I though was very profound (he was at the time strugling with performance and big positions)

“One interesting thing that I found about taking on large positions is that they crippled me from looking hard for other ideas.  It creates what is almost like tunnel vision.  This is another problem with this sort of strategy – lost opportunity.  I had convinced myself that because the market had run up so far there weren’t opportunities out there and that is why I was being forced into the corner with only a couple of ideas that I really liked.  The truth is that I simply wasn’t working hard enough.“

I think that has happened to me. I have had big positions in the past and one goal of this blog was to get more diversified. I was partly successful because at one time I think I had almost ten stocks in my portfolio and not too much cash. Byt now I’m back with big positions and too much cash.

When I was writing weekly on random stocks, good or bad, I was working and thinking all the time on new stocks and some of them ended up to my portfolio, not necessary at the time of the writing, but later (for example Martela and Ferronordic Machines).

But when I stopped writing on random stuff and when I took the big positions, the hard work kind of stopped and I started to complain on “no ideas”, for the reasons the quote above says (not working hard enough for new ideas, thinking that there is no ideas).

So as I write this, I have decided to bring the Martela position back to (my) normal which is 10%. I have also decided to do a new writeup on random stuff by next sunday before midnight Finnish time, no matter how good or bad, just get back on the working mode and routine, which at least last time lead to generating some goodies (Martela, Ferronordic, Kotipizza, Installux).

Happy Hunting

-Backoftheenvelope

ps. So I decided that my next weeks writeup will be about Millet Innovation, a French medical product stock I “gazed” recently. My thesis is that it might be GARP stock, the ones I like best:).

Edit 14.3.2017: Changed topic from “Portfolio and blog update” to “Portfolio and blog update Q1/2017”