Elevator Pitches, Issue #5: 12 New Ideas
New Stock Ideas from Investment Professionals
Welcome back to Elevator Pitches! In this issue, we found 12 new ideas we think are worth sharing. These ideas run the gamut from mega-cap down to micro. You’ll also notice this batch is over-indexed to “old economy” industries like trucking, pool services, and energy, compared to our earlier issues. Given the decimation of high-multiple growth and technology, that’s probably not a surprise, but it is very interesting to watch sentiment change in real-time.
Disclaimer: Nothing here constitutes professional and/or financial advice. You alone assume any risk with the use of any information contained herein. We may own positions in the securities listed. Please do your own due diligence.
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We start with an excerpt from Alta Fox Capital’s recent new buy of trucking company, Daseke. Please click through to read his detailed pitch.
Daseke (DSKE) from Alta Fox Capital: (Value with catalyst, Activist)
Alta Fox is currently a holder of Daseke, Inc. (DSKE) shares. Since Freightwaves released commentary on the U.S. truckload market on March 24, 2022, DSKE shares have fallen nearly 30% alongside other trucking stocks. The article accurately describes recent weakness in dry van rates causing public trucking stocks (all predominantly dry van operators) to fall materially.
However, DSKE is not a dry van operator. The Addison, TX-based company is predominantly a specialized and flatbed operator, a segment which is exhibiting different demand trends than dry van and is tied to different markets. We believe the relative strength of the flatbed and specialized markets is supported by their association with industrial, energy, and military uses (versus dry van which is tied to consumer goods demand).
Alta Fox believes the recent weakness in Daseke’s stock price reflects investors’ inability to differentiate between dry van weakness and flatbed strength and has created a tremendous opportunity in DSKE shares today. Alta Fox estimates that DSKE is now trading less than 7x forward earnings per share and a 20% normalized free cash flow equity yield for a business that we believe can organically grow EPS mid-teens annually as the company continues to simplify the corporate structure, eliminate inefficiencies, and expand EBIT margins to 8-15% through the cycle (600 bps higher than today), in-line with private flatbed operators of similar scale.
Earlier this week, Alta Fox urged Daseke’s Board of Directors to consider a meaningful stock buyback program to take advantage of current weakness, which would not be the first time that management has opportunistically repurchased stock. In Q2-Q3 2021, management repurchased ~$20M of DSKE stock at prices similar to current levels (~$7 per share). The market has once again presented management with a very compelling repurchase opportunity.
We believe the company can generate $1.61 in EPS by FY 2024 and trade at 12x PE resulting in a $17 share price, representing more than 100% upside from current prices. However, if the company utilizes its balance sheet to opportunistically retire ~10% of shares outstanding to take advantage of DSKE’s steep discount to fair value, the company could generate closer to $1.75 in EPS by FY24. With this ~$60M buyback, DSKE’s leverage ratio would remain comfortably below 2.5x. Not only would this increase earnings per share, but it would also increase confidence in management’s ability to effectively allocate capital.
Main Thesis Points
1) Daseke is in the early innings of a “self-help” story under new management which will improve bull market EBIT margins from <9% in 2021 to 15% over the next few years.
2) Daseke and the overall flatbed market are in a much better supply/demand situation than the dry van market right now--- a fact seemingly lost on Mr. Market.
3) The current valuation of <7x forward earnings and ~20% normalized free cash flow equity yield are extremely attractive given the strong fundamentals. Alta Fox believes DSKE could triple from today’s valuation on a medium term basis with reasonable assumptions, with even greater upside if management is able to buy back shares at attractive prices.
Volkswagen Group AG (VOW/VOW3.DE) from East 72: (special situations, value)
VW: Complex structure, enormous discount
One of the benefits of having been a stockholder for some years in Exor (EXOR.MI) is the perspective that following Exor affords on other structures. Given that Exor was effectively created in 2009 out of a controlling shareholding in (then) Fiat, which was a grab-bag of industrial, automotive and financial assets, and which via multiple spin-offs and asset sales has fuelled the Exor/Elkann phenomenon, when an even larger (controlled) organisation looks at a nascent version of a similar strategy, it’s little wonder markets get excited. The excitement was short lived, however, given this company is intrinsic to Europe, and is perceived to be impacted by the second round effects of the Ukrainian conflict and its China exposure.
Volkswagen Group AG (VOW/VOW3.DE) is one of the most complex “organisms” to analyse. What we write here is not an all embracing focus on its vehicle strategy, but an attempt to briefly conceptualise how undervalued the company’s shares – especially the preferred/non-voting shares – became during March 2022. We were fortunate to acquire a position in VOW3 and PAH3 (below) during the early March sell off in European markets at prices some 7 – 20% below those prevailing at quarter end.
VW is one of the ultimate sum-of-the-parts listed enterprises, on (at least!) eight levels:
1. the equity capital is split roughly 59%/41% between ordinary shares and non-voting (termed preferred) shares, but how should value be apportioned?
2. Operational versus financial profits, on numerous levels but most notably….
3. Vehicle manufacturing versus a significant €250bn+ asset based leasing and financial services business;
4. Cars versus trucks (and power engineering) within the manufacturing business;
5. Differing brand profiles within the cars business, most notably Porsche Automotive (henceforth “Porsche AG”) versus SEAT/Skoda/Audi/VW (not to mention Bentley and Lamborghini), which as we know with Fiat (now Stellantis) yield vastly different profit margins and valuations;
6. Equity accounted JV’s, notably China, China generally, and contributions from other investments;
7. The implied valuation (or otherwise) of electric vehicle initiatives, noting the extreme premiums investors are prepared to pay elsewhere (TSLA, RIVN); and
8. Special factors – the past negatives of emissions measurement scandals, and the imponderable of being a special, controlled company, which created its own town (Wolfsburg)
Let’s start simply before we delve into some of these factors. VW earned EPS of €29.65 in CY2021 leaving the non-voting preferred shares on a P/E of just over 5x. Improved earnings were driven by a €5billion operating improvement (€1/share equivalent) in the “core” automotive division and a stellar result in financial services with net credit from impairments aiding a €3bn boost to operating profit. This financial services result will normalise in 2022, but group consensus EPS is still above €30.50 per share – a P/E of 5x on these numbers.
So which instrument to buy? VW has two sets of equity instruments: 295m ordinary shares and 206m non-voting (termed “preferred”) shares; they have identical ultimate economic interest. Since the ordinary shares are 53.3% controlled by Porsche Automobil Holding SE (henceforth “PAH”, itself publicly listed), you would imagine the votes of the ordinaries should have limited value, and that there would be a minor gap between ordinary and preferred. Mr. Market thinks otherwise!
The preferred shares trade at around a 30% discount to the ordinaries, which is close to a 12year low. So we have bought these. However, we have also acquired preferred stock in PAH (PAH3 – the ordinaries are not listed) since PAH owns 157.2mn VOW ordinaries worth some €35.6billion which added to €670m of other assets gives PAH a pre tax NAV of €118/share6. We entered at a 32% discount at time of purchase, when NAV was ~€100.
VW has a number of public stockholdings but the most important at present is its 89.7% stake in the “securitised’ Traton SE, sold off in June 2019. Traton contains the Scania and MAN trucks business together with the newly acquired US company Navistar. The spun off company trades at a 38% discount to the IPO price of €27 as a result of ongoing restructurings and a difficult truck market. Investors remain sceptical despite management projections of strong 2022 growth.
However, the anticipated spin off which is getting investors excited was “announced” in late February, being the intention to split the Porsche AG (car manufacturing company) capital into 50/50 ordinary/preferred, spin off 25% of the preferred to investors and 25% of the ordinaries to PAH.
The excitement comes about because of a hoped-for replication of the legendary spin-off by Fiat of Ferrari (RACE) in late 2015/early 2016, where Fiat sold 9% of RACE for $52 into a NYSE listing, then span 80% more to Fiat-Chrysler shareholders on a 1-10 basis. At the time, immediately prior to the spin, Fiat-Chrysler shares were trading at $14; at 31 March 2022, RACE shares were $218 making the spin off alone worth 50% more than an investor’s Fiat holding on 3 January 2016.
We have no dreams of this happening and think some of the valuations (€90billion) placed on Porsche are far too high7. As a guide, Porsche (excluding its finance company) has averaged operating profits of €4.2billion over the past six years, and exceeded €5billion in 2021 on sales of €30.2billion. the marque sold 297,000 units last year at an average price of €102k. That’s not Ferrari. It sold 11,155 cars at an average of €321k. RACE (US$40.3billion market capitalisation at end March 2022) sells at 50x after tax earnings and EV/EBITDA multiple of 24.2. RACE is now significantly more expensive than other “luxury goods” companies, since it has high visibility of volumes and pricing over the next three years from its “waiting list”.
Does an 18x EV/Operating profit multiple stack up against this for Porsche? We don’t think so and have used a more conservative €60billion valuation.
On a sum of the parts basis, the figures for VW after a Porsche spin, at €60billion are compelling and reflect an ongoing issue in publicly traded securities of vehicle manufacturers, especially in Europe, of (in our opinion) not placing adequate value on the financial services businesses. VW’s disclosure ensures VWFS can be adequately separated.
Our rough figuring suggests that the traditional VW ICE8 business – which actually includes a significant electric component (see below) is attributed a negative value at end March 2022 of about €38billion (pre-tax) on a Porsche valuation of €60billion. Even placing it on a multiple of 2x operating profit suggests VW shares are worth some 50% more than the prevailing price.
Two other issues are highly relevant and interlinked: electric vehicles (positively) and China (potentially negatively). In 2021, VW Group sold just under 453,000 EV’s (excluding hybrids) – just under half of Tesla’s 936k - representing just over 5% of deliveries. Of course, EV’s are an essential part of the continuing growth for VW in China, which absorbed 3.3million vehicles last year (3.04million via its Chinese JV’s and the residue as imports) of which 92,700 were EV’s. China sales are ~38% of total VW group sales. VW market share in China has been falling marginally, and part of the steep share price decline in early March was reasonably attributed to “China fears” over the unknown stance towards the Russian invasion of Ukraine, and investor fears over over-exposure to markets with autocratic government.
Exor has been a controlled company since its reconstruction in 2009, but that has not prevented spectacular capital management through the recognition that proper valuation of all the group’s assets cannot occur if they are 100% owned; differential voting securities retain the control. Changing the structure is not an abrogation of history - the key is execution. EXOR have the record, VW don’t – yet – but they now have the chance to show this to a sceptical equity market which prices word class assets and manufacturing at exceptionally low levels.
Compañía Sud Americana de Vapores S.A. (VAPORES.SN) and Ultrapar Participações S.A. (UGP) from Third Avenue Value Fund
During the quarter ended March 31st, 2022, the Fund purchased shares of Compañía Sud Americana de Vapores S.A. (“CSAV”) and shares of Ultrapar Participações S.A. (“Ultrapar”).
CSAV is a holding company based in Chile and listed on the Santiago Stock Exchange. The company, which is ultimately controlled by another Fund holding, Quiñenco S.A., has a long and rich history leading to its current form. For decades, CSAV was the largest container shipping company, container terminal operator, and tug operator in Latin America. Prior to Quiñenco’s involvement, the company had increasingly drifted into disrepair and confronting its issues eventually required several very large rights offerings. CSAV was improved considerably through Quiñenco’s years-long effort to the point where it could eventually be pulled apart in order to achieve value creation. With its tugs and ports assets having been separated, CSAV’s container shipping business was then combined with Hapag-Lloyd AG to form one of the world’s largest container shipping companies. The transaction made CSAV a large shareholder in Hapag-Lloyd, which would later merge with yet another container shipping company, further participating in the global consolidation of the industry. As result of all of these transactions, CSAV’s primary asset today is its 30% holding in publicly-traded Hapag-Lloyd. At the moment, CSAV trades at a discount of roughly 75% to the value of its holding in Hapag-Lloyd. Container shipping companies are presently enjoying supernormal profits and we do not expect that Hapag-Lloyd will remain this profitable for a protracted period of time, but recent windfall profits have allowed the company to completely deleverage its balance sheet, bringing it to a point of overcapitalization, while also radically increasing dividend payouts. Hapag-Lloyd itself is currently trading at an approximate 11% indicated dividend yield8 and CSAV receives its proportionate dividend payment. With CSAV trading at a 75% discount to its stake in Hapag-Lloyd, that dividend yield, which has been flowing directly through CSAV to CSAV shareholders, is magnified by roughly four. Indeed, in early April, CSAV announced a dividend proposal which, when combined with a dividend it paid earlier in the year, amounts to a roughly 40% yield on the current share price. This level of dividends won’t last forever but it doesn’t need to last long in order for a substantial portion of our investment to be repaid in cash. Lastly, one might ask why CSAV exists at all at this point. The answer is that CSAV still has tax assets, accumulated during its troubled past, with which it shelters the income of the present. However, there is reason to believe that tax assets may be exhausted in the not too distant future given the size of dividends currently flowing to CSAV. In our view, it is reasonable to surmise that once CSAV no longer serves that functional tax sheltering purpose, it might be wound down in one of several ways. In each path, the size of the current discount to NAV would then become very relevant in thinking about the gains that might accrue to CSAV shareholders from that resource conversion event.
Ultrapar is a Brazilian fuel distribution and storage business. Operating under the Ipiranga brand name, Ultrapar is one of three companies with dominant fuel distribution networks in Brazil. With more than 7,000 service stations, Ipiranga holds an approximate 19% market share in Brazilian vehicle fuel distribution and also operates a related convenience store business under the AmPm brand. Ultrapar also operates one of Brazil’s largest Liquefied Petroleum Gas (“LPG”) distribution businesses as well as one of Brazil’s largest bulk liquids storage terminal networks. The Brazilian equity market has, in recent years been a relatively poor performer, particularly as measured in U.S. dollars. Ultrapar is one example of a relatively high quality Brazilian business that is currently available at valuation levels we haven’t seen in some time. Additionally, like many businesses in Brazil, the fuel distribution business has a few country-specific complexities. In the main, we would say that the overall direction of policy in Brazil has made operating the business more straightforward and the separation of several businesses in the energy storage and distribution arena from state-controlled Petrobras is gradually allowing the industry to operate in a more traditional arms-length manner. Further, as it relates to Ultrapar specifically, in recent years, it is generally accepted that Ipiranga has been the least well operated of the big three fuel distributors. This is most glaringly evidenced by routinely inferior fuel distribution margins. Ultrapar also spent years making ill-advised acquisitions in an attempt to diversify, a process which is currently being put into reverse. The disposition of several large but noncore businesses has led to a substantial cash inflow recently, putting Ultrapar on excellent footing to make operational improvements and, potentially, to make strategic additions to its business. This strategy will be executed by a new CEO, to whom Ultrapar’s controlling family has made a considerable financial commitment. We have high-regard for the new CEO, having familiarity with him from his previous career at Cosan S.A., another one of Brazil’s big three fuel distributors. In summary, we think that there is a lot of room for operational improvement as well as general valuation upside at Ultrapar
Kovitz initiated new positions in Spotify (SPOT), Hayward Holdings (HAYW), and Jacobs Engineering (J). All are included below.
SPOTIFY TECHNOLOGY (SPOT)
Spotify is a pioneer in the music streaming business. The company has been largely responsible for returning the music industry to growth after years of decline that started when the rise of music-sharing service, Napster, began to decimate the sale of physical music media in the late 90’s. Spotify has also played a leading role in the transformation of the music industry into a more collaborative effort among artists, studios, and distributors. They are also quickly becoming the leading global podcasting platform. Over time, we expect their geographic expansion, market share gains, and development of an auction-supported ad network (similar to YouTube) to generate significant levels of free cash flow relative to the capital employed.
Spotify’s services are extremely well-liked by the vast majority of its customers as evidenced by an extremely low churn level among premium subscribers. We envision Spotify becoming the scaled leader in audio distribution, with the most options to monetize the ongoing shift from radio/physical sales to digital.
Current cash flow is likely depressed as Spotify is spending aggressively on R&D to continually improve the customer experience, building out an attractive lineup of exclusive podcasts, and marketing extensively to acquire premium subscribers. Looking further out however, our projections of normalized free cash flow levels support our view that shares of Spotify offer an attractive entry point to own one of the few platforms that can plausibly reach over 1 billion users (from a current base of roughly 400 million) as the company and industry mature.
HAYWARD HOLDINGS (HAYW)
Hayward is a relative newcomer to the public markets, having IPO’d slightly more than a year ago. However, the company has a long operating history in the oligopolistic pool supply industry as a global designer, manufacturer, and marketer of a broad portfolio of pool equipment. This niche industry has delivered exceptional economics for a wide range of businesses that participate in it and has typically grown at 1.5x-2x GDP for much of its recent history. This is driven by a steadily rising installed base of pools in the U.S., particularly as demographic trends have favored migration to warmer-weather locales, and the need to regularly maintain and replace broken equipment to keep it usable. Further supplementing demand have been vast improvements in the efficiency of equipment that significantly reduces the cost to operate a pool and a growing desire of pool owners to integrate more technology and automation into their pools to save both cost and time.
Shares have traded down roughly 40% over the past several months as fears of a reduction in home improvement spending from the COVIDinduced “stay at home” demand levels reached last year. While we are conscious of these fears, we note that the majority of Hayward’s business is comprised of maintenance equipment that is primarily non-discretionary in purchase. Moreover, as noted above, the majority of pools are located in regions that we expect to continue to see net migration as a more remote workforce and the Boomer generation continues to choose warm weather over snow.
Given industry reports of contractor backlogs going out past 2022, continued inventory constraints supporting home prices, and the solid base of non-discretionary maintenance spending on pool equipment and supplies, we believe the current valuation of Hayward’s shares should provide attractive returns in most economic scenarios.
JACOBS ENGINEERING (J)
Jacobs is a name that we have successfully owned before, having recently exited the position between $130-$140 per share in the April-June timeframe of last year. While our new entry price is only slightly below those levels, our internal estimates for the company’s long-term earnings power have increased dramatically. Recent developments related to the Infrastructure Investment and Jobs Act bill signed into law last November and clearer indications of contract wins in secular growth fields such as life science, semiconductor manufacturing, and cyberdefense have driven upward revisions to our financial models. Combined with our long-standing appreciation of CEO Steve Demetriou and the likelihood that these newer contracts will have better economic terms for Jacobs than prior commitments, we think the current share price offers a high probability of meaningful returns with less potential economic sensitivity than in the company’s past.
We also completed a couple of relatively wide-ranging rebalancing trades during the quarter. In broad strokes, we continued to pare back our weightings in some of the best performing names in the portfolio and have allocated that capital towards other strong franchises in our portfolio that have more upside to our business value estimates.
We finish this issue with 5 quick hitters from Greenlight Capital.
We added small new positions in International Seaways (INSW), Ryanair Holdings (Ireland: RYA), TD SYNNEX Corporation (SNX), Southwestern Energy (SWN), and Weatherford International (WFRD).
INSW is an owner and operator of oil tankers and product carriers. Demand for oil fell during the pandemic, leading to a prolonged period of low charter rates for tankers. We acquired our shares during the quarter at an average price of $15.30, or less than 60% of INSW’s liquidation value. With oil demand having now recovered to pre-pandemic levels and no shipyard slots available for the construction of new tankers for several years, we expect a tighter market, and with it, INSW’s discount to its NAV to close. Management has been a good steward of capital, acquiring ships during low points in the cycle and repurchasing shares at attractive prices. INSW shares ended the quarter at $18.04.
RYA is the largest low-price European airline. During the pandemic, RYA expanded upon its industry-leading low-cost position by upgrading and improving the fuel efficiency of its fleet and by reducing its airport costs. RYA has created a competitive advantage by hedging near-term fuel prices. As a result, we expect RYA’s earnings to exceed expectations as demand for air travel further recovers. We established our position at an average price of €13.93, or 11.6x this upcoming fiscal year’s EPS forecast. RYA shares ended the quarter at €13.59.
We reinitiated a position in SNX as we believe the company’s recent merger with Tech Data has created the top global IT distributor with potential for significant EPS accretion through cost and revenue synergies. The company recently held its first analyst day since the transaction closed in September at which management laid out a path that we believe will achieve EPS of $20 in a few years. We acquired our stake at an average price of $105.33, or just over 9x current year consensus EPS. SNX shares ended the quarter at $103.21.
SWN is the second largest producer of natural gas in the U.S. The company is well-situated to satisfy growing domestic and export demand. Over the short, medium and long term, Europe now intends to reduce its reliance on Russian energy and increase its use of U.S. LNG. Based on its 2021 year-end reserves – which assumed a $3.60/MMBtu long-term natural gas price – SWN has a PV-104 value of $13.83 per share. By the end of the first quarter, the U.S. natural gas 5-year forward curve averaged $4.28/MMBtu, while international seaborne LNG was close to $20/MMBtu. Over the intermediate term, with the benefit of substantial global investment in infrastructure, we expect prices for U.S. and international natural gas to converge. We acquired our shares at an average price of $6.58. SWN shares ended the quarter at $7.17.
WFRD is a global oilfield services company that provides drilling tools and other products and services required to produce oil and gas. Due to poor execution and a lot of debt, the company went bankrupt in 2019. It has since emerged as a less levered, better managed, and cashflow generating business. WFRD now has the wind at its back as many years of underinvestment in exploration and production have left the world structurally short of oil. The company stands to benefit from the significant increase in exploration and production capex that is underway. We acquired WFRD shares at an average cost of $32.27, or 5x EV/2022 EBITDA, while its three largest peers trade between 11x and 13x EV/2022 EBITDA. WFRD shares ended the quarter at $33.30.
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Until next time! - Elevator Pitches