December 2019 | Quarterly Report

Introduction

The Fund posted quite strong returns over the quarter. The Euro share class was up 5.7%, and the newly introduced USD share class was up 9.0% since its inception on 15 October 20191  . The Australian Fund’s 4.4% quarterly return was dampened by the rising AUD. For interested readers, we again refer to past quarterly reports for the longer term performance of the Australian Fund, which are available on our website.

We feel we were well due some decent returns given the ‘cheapness’ of our holdings.

The Fund has been operating since 30 January 2019 and delivered a return of 6.8%1  . Although we do not expect to ‘shoot the lights out’ with year on year double digit returns, this is below our long term expectations of performance.

What is in even more stark contrast to our long term expectations is the 22.8%2   (in Euro terms) return of the broader global equity market (as measured by the MSCI World Index) over the period of the Fund’s life.

“The longer the bull market lasts the more severely investors will be affected with amnesia; after five years or so, many people no longer believe that bear markets are possible” – Benjamin Graham

Investment is about taking on risk with the expectation of reward by way of return. Being cautious over recent years has gone largely unrewarded. Whilst the risks we are prepared to accept have delivered modest returns, the risks that we are not willing to tolerate have generally delivered higher returns. In our view, this is largely a result of excess liquidity being pumped into the system, which has driven prices of all equities (particularly index constituents) regardless of their underlying business fundamentals. But we will not be blindly succumbing to this momentum market. And if this stance continues to be a drag in terms of relative performance, we will continue to be accepting of it.

Snapshot

  • There was a broad range of positions that contributed to the Fund’s strong returns.
  • Only three of the Fund’s holdings posted a negative return over the quarter.
  • It is pleasing that the strongest performers were large, longer term, high conviction positions, such as Lear Corporation3  , Dick’s Sporting, Thor Industries and Samsung.
  • Two recently introduced companies (Linamar and Methode Electronics), which both cater largely to the automobile industry, performed well. Whilst gratifying to see the positive short term outcome, this is no sign of trading prowess.
  • We have sold our positions in Gap (after it announced poorer performance than we expected and the resignation of its CEO) and L Brands (as its Victoria’s Secret business is yet to show signs of recovery).
“There are some people that don’t like making mistakes, [if so] don’t go into money management.” – Jean-Marie Eveillard”
  • The only other trading involved a slight increase in our Lear Corporation position at a time of price weakness.

Contribution

Figure 1: Top Contributors/Detractors (Quarter)4  

Source: Alluvium, Factset, Private Reporting Pty Ltd.

Contribution

Figure 2: Top Contributors/Detractors (Since Inception)4  

Source: Alluvium, Factset, Private Reporting Pty Ltd.

Contribution (continued)

Table 1: Contribution Details

December 2019December 2019 Quarter SummarySince Inception Summary
StockEnd WeightBeg. WeightReturnContributionBeg. WeightReturnContribution
Dick's Sporting6.2%5.6%21.8%1.1%42.6%2.1%
Ryanair4.8%3.6%38.6%1.5%51.4%1.9%
Samsung Electronics3.8%3.5%13.8%0.5%30.1%1.0%
LyondellBasell5.9%6.1%6.8%0.4%14.4%1.0%
JAE18.5%0.7%
McKesson4.2%4.6%1.4%0.1%22.2%0.7%
Delta Air Lines3.0%3.2%2.1%0.0%20.0%0.7%
Thor Industries3.5%2.9%32.2%0.9%16.0%0.7%
Linamar4.3%2.8%13.7%0.6%15.5%0.7%
Gap1.3%-0.7%0.0%-32.9%-0.7%
Western Forest1.6%1.7%3.1%0.1%-32.9%-1.0%
L Brands2.8%-5.8%-0.2%-25.8%-1.2%
Subtotal37.3%38.1%5.0%6.6%
Other Equities46.4%43.9%1.1%1.6%
Cash, Currency and Fees16.3%18.0%-0.4%-1.4%
Total (EUR)100.0%100.0%5.7%5.7%6.8%6.8%

Source: Alluvium, Factset, Private Reporting Pty Ltd.

Table 2: Quarterly Purchases

Kirkland LakeNew Position
RocheNew Position
AlphabetNew Position
Northern StarNew Position

Table 3: Quarterly Sales

F5 NetworksComplete Sale

Performance Review

The Fund’s holdings posted generally strong returns across the board over the quarter.

The strongest performance came from Ryanair, the European budget airline. The collapse of Thomas Cook (the UK based tour operator and airline) in late September will lead to a more rational market and more favourable future operating conditions. This is expected to benefit the remaining European budget airlines, including Ryanair, which we believe is the strongest operator in the region. And despite the setbacks from ongoing delays of its Boeing 737 Max deliveries, we are of the view that Ryanair will maintain its leading position. We progressively accumulated our position from June to September. Ryanair returned 38.6% for the quarter (up almost 50% from our purchase price), and had grown to be a 4.7% position by the end of the year. Although no longer the compelling opportunity it was 6 months ago, we do not view it as over-priced at these levels.

Thor Industries, which the Fund has owned virtually from inception, returned 32.7% over the quarter. It hosted an investor day that was favourably received and it reported solid quarterly results. Most notably, dealer inventories are subsiding to normalised levels, and its European acquisition is performing as expected. Whilst all this is undoubtedly positive, the strong run in its share price now has Thor trading at almost a 20% premium to our conservative valuation.

Both Thor’s CEO and Ryanair’s CEO have significant stakes in their respective companies, and both increased them over the quarter. Thor’s CEO bought more shares during the quarter. Ryanair’s CEO didn’t – probably because he would have been competing with Ryanair itself as it was actively buying its shares.

“When taking a flight, you want the pilot on the plane for the ride.” – Leon Levy

Business at Dick’s Sporting is progressing well. It reported impressive third quarter same store sales growth of 6% and upgraded its full year guidance (which at mid-point would represent 13.5% earnings per share growth). After returning 22.0% over the quarter, its business is now priced at an earnings yield of around 8.8% and in-line with our estimated value.

Turning to Japan, T-Gaia, the telecommunications reseller was up 21.8% and Tosoh, the chemicals producer returned 18.7%. Together these holdings represent only around 5% of the Fund but contributed over 1.0% to its quarterly return.

Moving to the troubled automobile sector. On October 25 the United Auto Workers union (UAW) ended its strike at General Motors US plants. This was the longest automobile strike for 50 years, stopping production at more than 30 plants and costing original equipment manufacturers (OEMs) millions each day. So, the 48,000 workers returning and the revival of production was undoubtedly a huge positive for our investee companies in this sector. Our long-held conviction position, Lear, was up 17.1%. Also, we benefited from our two new positions as explained below.

We started buying Linamar (discussed in the next section) in the last few days of September only to see it tumble over 10% on 3 October when it provided an update on market conditions (including a CAD1m per day earnings hit from the then current UAW strike). We considered these to be largely temporary in nature, so we took advantage of the opportunity to increase our position at a more favourable price than we had paid initially. Linamar closed the quarter 17.5% higher than our average cost.

We also accumulated a 2% position (too small in hindsight) in Methode Electronics in late October. Methode is a global manufacturer of a diverse range of electronic devices, interfaces and lighting systems principally catering to the automotive industry (but increasingly to other industries). In December it announced second quarter results. In contrast to Linamar, this time a favourable price reaction was unfortunate as we were yet to complete our buying.

Despite the strong share price gains, we still view Linamar and Methode as attractively priced.

The only detractors of note were L Brands and Franklin. L Brands (down 7.5%) has been the worst investment for the Fund to date, and it is discussed in the next section. Franklin, the investment manager, was down 10% over the quarter (although it did pay a dividend). Despite it being a small position (around 2%), that hurts! Franklin announced its full year results, and the appointment of a new CEO. The results were not particularly encouraging, and we are certainly not enamoured with this company. Do not be surprised if our loss from this investment is realized shortly.

Linamar: Why We Own It

Linamar was founded by the Hungarian born Frank Hasenfratz in the mid-sixties in Ontario (Canada) and is now run by his daughter, Linda. It specializes in the precision manufacturing of high volume metallic parts, and mostly caters to the automotive industry. As two-thirds of its CAD7.6b annual sales is still made up by General Motors, Ford, Chrysler and Caterpillar, it is rightfully considered an OEM.

Worldwide auto sales have been falling for the last two years and are expected to remain weak in the foreseeable future. And Linamar’s share price has reflected this, having fallen around 50% over the two years to October. However, despite being classified as an OEM, 40% of Linamar’s earnings are derived from its industrial business which manufactures agricultural equipment and scissor lifts. And the company intends to further diversify its earnings, with a focus on the power, water and medical devices markets. All require manufacturing expertise, which Linamar has in abundant supply. The most recent example of this was announced in December. Linamar struck an exclusive agreement with Synaptive (a medical imaging business) to manufacture its patented Modus V™ robotically-controlled digital microscopes and Evry™ head only magnetic resonance imaging (MRI) system.

We like being shareholders of companies which have understandable business models that are unlikely to be disrupted overnight. We suspect many view this company as a vulnerable manufacturer in a tough, cyclical industry – an industry undergoing significant disruption with the progress of electric, fuel-cell and autonomous vehicles. Conversely, we see a company with a solid track record of consistent sales growth (5-year average of 16%) which together with its growing margins (from 6% in 2011 to 11% today), has led to consistently growing earnings. It has increased its market share in all of its segments (driven by fewer competitors and product expansion). It has been successfully counteracting the headwinds of declining automobile sales with growing its content in each vehicle sold. And the opportunity is there for this to continue.

On top of that impressive financial performance, in our view the trend for auto manufacturers to increase their outsourcing is likely to continue. If so, the result would be increased opportunities for the ‘best in class’ OEMs like Linamar to profit from their specific expertise in areas like powertrains, drivelines and fuel cells.

We believe your money is in good hands. Linamar’s management team strives to maintain its entrepreneurial culture that led to the success of the business. Part of this includes keeping a strict control on capital allocation by applying some basic rules as described in Mr Hasenfratz’s book, ‘Driven To Succeed’, like: not spending more than a year worth of cash flows; aiming for two dollars of revenues after two years of operations for each dollar spent; and keeping debt to less than 25% of equity.

We like a business that considers its 27,000 staff as part of one team, that is focused on operational excellence and obsessed about keeping costs to a minimum. We like shared ownership with a founding family that has a genuine long-term vision and a clear strategy. We have accumulated our position at a price that we think reflects a beaten down stock in an unloved sector. But to us it looks more like an investment in a ‘growth’ business at a ‘value’ price.

“If you’re going to do everything the way the book tells you, you’re just another company. You can make a living, but that’s not the idea – just to make a living. The idea is to create something.” – Frank Hasenfratz

Closing Remarks

After a year where we have significantly lagged the index, we like to reassure ourselves: no one can judge the quality of a decision from its outcome.

Sometimes events transpire in unfortunate ways. After months of paperwork the Fund was finally approved to start on 30 January 2019. This meant we ‘missed’ the January ride – awarded the ‘best month of the year’ by far with a 7.4% return. And with our risk averse approach in taking our time to deploy the Fund’s capital, we held very high cash levels during the market’s subsequent returns of 3.8% in February and 2.7% in March.

At the time of the Fund’s inception, which followed one of the strongest bull markets on record, our view was that most equities were expensive. And despite being below our longer term expectations, we would have been accepting of a 6.8% return over the remainder of the year. But we do not live in a ‘closed’ world, independent of our peers. Achieving a reasonable (but far from spectacular) result in such a buoyant market is, quite frankly, very frustrating. Fortunately we plan to manage assets for another few decades (at least we hope), not just for one single year.

It is painful to speak of our poor investments, which most notably were L Brands and Gap. Together these positions cost us almost 2%. So, what went wrong? Our quantitative process to a large degree relies on ‘mean reversion’ of earnings. But after a few recurring quarters of poor results, and with little signs of improving prospects, we reluctantly accepted that if the earnings from these business were to indeed ‘revert to the mean’ it would be sheer luck. And luck cannot be part of our process.

Our philosophy of ‘value’ investing is set in stone. The method by which we implement this philosophy, ie our process, however is subject to evolve over time. And reflecting on some trends which we consider to be ongoing, like the transition from manufacturing to service based economies, increasing benefits of scale, and more rapid business obsolescence, we have been progressively including a more meaningful level of qualitative input to what has been our overwhelmingly quantitative process. As we do so we recognise that our main challenge is to limit the extent of behavioral bias that, by necessity, are inevitably introduced. And we continue to stick to our values and style and that is something we are proud of, won’t change, and are confident will pay off in the longer run.

“You need to control greed and fear, hopefulness and despondency. You have to resist making an unwise bet just because it could enable you to catch up with the indices or the competition.” – Howard Marks

Interest rates keep getting lower… even already in negative territory. Of course, levered companies are thrilled. Growth investors are thrilled. Passive investments keep on growing, mechanically inflating prices of the index constituents and deflating prices of the ‘left behind’. As the spiral unravels (which we are confident it will), we believe the pendulum will swing back to stocks like those in our portfolio. These are companies largely outside the indices, that house businesses that may not be growing so quickly but have protective elements, and are conservatively financed. Don’t get us wrong: we do not have a view on the markets, we just have a view that our portfolio has a more attractive risk/return profile than an index portfolio.

So, we are ready, we stand by!

Stuart Pearce
Principal

30 January 2020

Alexis Delloye
Principal

Profile

Figure 5: Diversification by Sector

Source: Alluvium, Factset

Figure 6: Diversification by Region

Source: Alluvium, Factset

Table 4: Fund Overview

Cash16.3%
Top 15 holdings63.1%
Number of holdings24
Weighted Average Market Cap. (USD m)32,242

Source: Alluvium, Factset

Table 5: Quality Metrics (weighted average)

Debt (% of EV)20.7%
Sales Growth (3y average)4.9%
Return on Invested Capital (3y average)25.4%
Return on Invested Capital (8y average)29.7%

Source: Alluvium, Factset

Table 6: Pricing Metrics (weighted average)

Enterprise level yield (EBIT/EV)9.8%
Earnings yield (NPAT/Mkt Cap)8.6%
Free cashflow yield (FCF/Mkt Cap)6.1%

Source: Alluvium, Factset

Table 7: Top 15 Holdings

Lear Corporation6.3%
Dick's Sporting6.2%
LyondellBasell5.9%
Ryanair4.8%
H&R Block4.4%
Linamar4.3%
McKesson4.2%
Samsung Electronics3.8%
Capri Holdings3.7%
Gilead3.5%
Thor Industries3.5%
Tosoh3.5%
Walgreens Boots3.2%
Delta Air Lines3.0%
Methode Electronics2.9%

Source: Alluvium, Factset

Definitions

General

Alluvium: Alluvium Asset Management Pty Ltd, ABN 69 143 914 390, AFSL 476067
Australian Fund: Alluvium Global Fund
Factset: Factset Research Systems, Inc.
Fund: Conventum – Alluvium Global Fund

Portfolio Metrics

Enterprise Value (EV): The market value of equity plus the book value of debt
EBIT: Earnings before interest and tax
Earnings Yield: The most conservative result from four different calculations at the equity level
Free Cash Flow (FCF): Cash flow from operations less capital expenditure
Mkt Cap: Market capitalisation
NPAT: Net profit after tax
Operating Assets: Total assets less total liabilities plus total debt (Alluvium adjusted)
Owner’s Earnings: Operating cash flow, plus cash interest paid less assumed maintenance capital expenditure
Return on Invested Capital: Owner’s Earnings as a percentage of Operating Assets

Footnotes

1 Source: European Fund Administration S.A.

2 Source: Factset

3 Company names have been abbreviated throughout this document in the interest of readability.

4 Returns are time weighted, include dividends, and are expressed in local currency.

Alluvium is solely responsible for the preparation of this document.

The Fund is a sub fund of Conventum. Conventum is an open-ended investment company (société d’investissement à capital variable, “SICAV”) with multiple sub-funds incorporated under Luxembourg law, subject to Part 1 of the Luxembourg Law of 17 December 2010 on undertakings for collective investment, as amended. The SICAV has appointed Conventum Asset Management S.A. as the Management Company in charge of the portfolio management, the central administration and the distribution of the SICAV. Conventum Asset Management S.A. has appointed Alluvium as the Asset Manager of the Fund. Relevant documents for the Fund are available via the following links: Prospectus (FR/EN), Key Investor Information Document (“KIID”), (FR/EN).

Alluvium is the issuer of units in the Australian Fund, which is an unregistered managed investment trust available to Wholesale Clients as defined under Section 761G of the Corporations Act 2001 (Cth). The Australian Fund feeds into the Fund. An Information Memorandum (“IM”) is available here.

A person should obtain a copy of the Prospectus, the KIID, and/or the IM and should consider the documents carefully before deciding whether to acquire, or to continue to hold, or in making any other decision in respect of shares in the Fund or units in the Australian Fund.

This document was prepared by Alluvium and does not contain any investment recommendation or investment advice. This document has been prepared without taking account of any person’s objectives, financial situation or needs. Therefore, before acting on any information contained within this document a person should consider the appropriateness of the information, having regard to their objectives, financial situation and needs. Neither Alluvium, nor its related entities, directors or officers guarantees the performance of, or the repayment of capital or income invested in, the Fund nor the Australian Fund.

By | 2020-01-30T15:16:42+11:00 January 2020|Reports|0 Comments

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