Wabash contributed most meaningfully to the Fund’s returns. The share price increase of over 20% was one factor, but also volatility was our friend here. We were able to take advantage of a sharp price decline in early November and we more than doubled our position prior to a significant rebound over the last two months of the year (refer to our article What we do when another of our holding plummets on release of earnings). Further, we note that due to subsequent ongoing price strength its position size caused breaches of our diversification rules, so post year end we trimmed our position a little (however it still remains around 5% of the Fund).
The next two top contributors ended up being short term holdings. This is disappointing in some respects, as our preference is to hold for the long term. There was a sharp rise in the share price of Urban Outfitters after the release of its quarterly result in October, to the point whereby the rules allowed a “discretionary sell”. As we were concerned the price encapsulated lofty expectations that the business may fail to deliver, we ended up only holding it for around six weeks before realising a gain of more than 30%. Interestingly, the price has now (as at late January) reverted to an interesting level below our original purchase price, so it may well re-enter the portfolio. Monadelphous was sold in two tranches, the first to address portfolio diversification (as it became too prominent in the portfolio) and then after it reported results which, upon our analysis and rules, required divestiture.
It seems the market viewed American Public Education as one business set to reap benefits from Trump’s policies. The share price was decimated after it reported third quarter results in early November, but then rebounded to above its prior level within two days and went on to finish the year up another 16%. With our updated analysis and rules indicating a “hold” we rode out the volatility to the Fund’s benefit.
We continue to hold Transcontinental (a Canadian media, publishing and packaging company) and American Railcar Industries, a designer, manufacturer and fleet manager of railcars.
Our position in retailers hit us hard.
We purchased Vera Bradley in two tranches (early October and early November) and in both cases we are substantially underwater. This is a business which has experienced declining fundamentals over the last three to four years. However, it is cheap, it has no debt and its lease obligations are, in our view – so far manageable (although we are waiting for the next annual report which is expected in late March to provide further disclosure in relation to the lease obligations). We hope that with the benefit of a longer period of hindsight we will look back at this from a happier light and simply acknowledge that we can rarely pick the most ideal point of entry.
Debenhams was a disappointment. This business has featured in our June and September reports, and here we are again. We sold our remaining position in mid-October. In local currency terms, we lost around 25% of the capital we invested (and with the marked decline in the British pound, we fared quite a bit worse in AUD terms). What went wrong? As we hypothesized in the September quarterly review we think we failed to adequately consider “hidden” leverage associated with its long term lease liabilities.
A highly leveraged business that experiences a marked decline in fundamentals is a dangerous proposition, and this was reinforced to us via this experience. As we mentioned in our September report, we have now created new rules to become more discerning around investing in capital intensive business operations with hidden financial leverage (off balance sheet liabilities where assets are leased, rather than owned). As a result, we are less likely than otherwise to hold positions in retail companies and airlines.
GameStop released results which according to our analysis revealed deteriorating financial strength, and therefore it was a position with an increased level of risk. In circumstances like these, our experience suggests we are best to minimise risk, sell the position and accept a short term loss. At least we have an ancillary benefit of offsetting some short term capital gains.