Over the first quarter of 2015 my benchmark gained 19.1%. What an unprecedented run!
During the quarter the portfolio has not outperformed the benchmark (the goal over a full market cycle). To the contrary, the portfolio underperformed by a wide margin gaining only 8.1%.
Reasons for this underperformance are threefold:
First, the average cash position of 32% cost 380 bps of performance during the quarter. So a more concentrated approach with higher weightings per investment would have been beneficial to performance.
Second, the portfolio contains a number of special situation investments. In general, their performance shows a low correlation to the equities indices. While special situations including Retail Holdings, Eredene Capital, UMS and the German and Italian real estate funds make up 18% of the total portfolio they contributed only 34 bps to the total quarterly performance.
Third, some of the share prices of the companies I own did barely move during the quarter. These investment make up 16% of the portfolio, but they contributed only 48 bps to the total quarterly performance. This part of the portfolio contains the following investments:
All of these companies can be classified as micro caps. Moreover, most of them have large insider ownership, with management holding a substantial percentage of the outstanding shares. This leads to a small free float accompanied by a relatively low market cap. These companies are even small relative to the components of my two benchmark indices. My combined benchmark has a weighted average free float market cap of USD 1.3 bn.
As a consequence, micro caps are not part of any major indices. Therefore, they are not available to passive investors buying these indices via ETFs or other structured products. However, most of the new funds entering the equities markets have been directed towards passive investing not only over the recent quarter but for years now. Consequently, the chances are high that micro caps do not perform in line with the indices over the short to mid term.
However, this argument can only be part of the equation. More important is the operating progress the companies make and whether this is in line with my original investment case. So let’s have a closer look at the underperformers of the first quarter:
Olympic Entertainment Group (OEG) is progressing well. In its core markets Latvia, Estonia and Lithonia OEG defended its strong market position and high operating margins. However, the less important markets Poland and Slovakia had some problems. In Poland management reduced the number of casinos from 3 to 2 and in Slovakia costs with regard to the acquisition of a slot operator and the opening of new casinos led to an operating loss in this country. The company has also expanded its footprint in Italy. While total net profit decreased by almost 17%, operating cash flow generation remained strong down 8% but still 22% of revenues with only small changes in working capital.
As in 2013 the company spent more than EUR 4 m (12% of operating cash flow) for acquisitions. The construction of the hotel/casino in Tallinn (the only one owned by the company) is progressing according to plan and cost EUR 10 m (31% of operating cash flow) in 2014 alone. The opening is scheduled for next year and the hotel will be operated by the Hilton Group. Other investments made up EUR 9 m leading to a free cash flow of EUR 9 m in 2014. Recently, OEG announced that it will invest up to EUR 7 m in the establishment of a new casino in Malta in cooperation with Maltese hotel and entertainment enterprise Eden Leisure Group. Once completed this will be OEG’s largest casino with close to 2,700 sq metres. Opening is scheduled for the second half of 2015.
The company published also good Q1 2015 sales numbers with revenue up by 12.1%. So it seems to be the case that the weakness of the Russian economy has not affected OEG’s results yet.
Due to the strong cash flow generation, the company can finance its expansion into other markets and the market share build up in existing markets without the use of debt. Since 2011, OEG has increased the number of casinos from 61 to 93. In my original analysis, I mentioned that management overacted before the financial crisis by increasing the number of casinos to 133 in 2008. A costly restructuring followed afterwards. I believe that management has learned its lesson from that experience (the current CEO was not on board at that time but the chairman and largest shareholder) and therefore is now reinvesting capital with a more sustainable approach to become a long term compounder.
In August 2014, I invested in Francotyp Postalia. Preliminary numbers for 2014 were in line with my expectations. Due to the large investments in the rental business free cash flow was negative. Nevertheless, I assume that the substantial investments made over the last years will generate significant cash inflows in the periods ahead. On top of that, the restructuring is mostly completed now and I expect the company to benefit from significant cost savings in 2015. As a consequence, my original investment case remains unchanged.
With the completion of the acquisition of BHF-Bank, the conversion of the co-investors’ share in BHF-Bank into shares of RHJI and the re-organisation of RHJI to a single-tier holding structure underway, RHJI was renamed to BHF Kleinwort Benson Group (BHF KB) in February 2015.
Results for the year ended 2014 showed operating improvement. The operating loss adjusted for the negative goodwill from the BHF-Bank acquisition and other non-recurring items (positive in the case of BHF-Bank and negative for Kleinwort Benson) was reduced by EUR 18.8 m to EUR 23.5 m. While BHF Bank posted a EUR 2.2 m operating profit, Kleinwort Benson generated a EUR 4.9 m operating loss. However, the majority of the operating loss is coming from the group or holding level. Here, costs are still very high which is partly due to rental payments for the London office building, transaction costs for the acquisition of BHF-Bank and holding costs due to the complex structure. In addition, many shareholders have also been complaining for years about excessive management compensation at the holding level. At the holding level, I estimate that there are still EUR 70 m of liquid assets and other investmts. The question is what happens to this capital and how it is used.
On the other hand, with the acquisition of BHF-Bank, the group owns a private/corporate bank with a focus on small and medium enterprises and their owners (“the German Mittelstand”) in the largest European economy. At a 0.7x price-to-book value, the acquisition price was quite attractive (though profitability is pretty low at the moment). Apart from that, 45% of BHF KB’s shareholders have a lock up period until 2017, which might have a stabilizing effect on the stock price.
Management’s goal is to reach more than EUR 60 m of operating profit in 2017. The current market cap is already EUR 615 m and I expect the company to sit on EUR 70 m of free cash and investments. Let’s assume I require a 12% return over the three year period until 2017. As a consequence, the market cap had to increase to EUR 865 m. This will value the group with a 13x multiple on operating profit in 2017 (assuming that cash and investments remain unchanged). At the same time return on equity will range somewhere between 6% and 7%. Hence, looking at future potential profitability instead of price-to-book is not really encouraging. Consequently, in this case I will closely follow the results on a quarterly basis (normally, I do not give too much weight on quarterly results).
I invested in Steico in October 2014. Management presented mixed preliminary results for 2014 in February. While revenue increased by more than 10% operating income was up only 4%. This is below my expectations. Pricing pressure was ongoing in the wood fibre insulation segment throughout 2014 and margins in the growing I-joist segment were under pressure due to increasing input costs. Margins in the later segment are expected to increase from autumn 2015 onwards, when the new production line for laminated veneered lumber (LVL) is expected to be completed. LVL is used for the production of I-joists. With the release of the 2014 annual report it will also be interesting to see whether management is on its way in optimizing the capital structure to enhance returns on equity going forward. Overall, the investment case is still intact.
Passat was not only my first investment written up on this blog, but has also been the worst investment so far. Since the start of the portfolio this investment provided a negative contribution to total performance of 87 bps. The decline in the stock price is a reflection of the company’s sluggish operating performance. While revenue decreased by 7.9% operating income fell by 45.8% in 2014. The decline in consumer spending in France and Southern Europe provides an obvious reason for this development. However, management is also talking about increased competition. In addition, the company will be suffering from the strong USD, as most of their products are imported and paid for in USD. As a consequence, there are reasons to doubt that management can turn around the business in 2015. On the other hand, net cash is almost EUR 12 m. So the operating business is only valued with EUR 9 m, while generating revenues of close to EUR 50 m. Overall, Passat is one of the top candidates for a disposition.
RealDolmen’s fiscal year will end in March 2015. Management expects operating margins to be in the low single digits due to a weak first half and ongoing restructuring charges. Revenues are expected to reach last year’s level. After the sale of its French subsidiary, the IT service company focuses on Belgium and Luxembourg. Over the last years demand has been subdued as many clients reduced their budgets for IT spending. Recently, the company won a large 5 year contract from the Flemish government which will start to generate revenues from mid-2015 onwards. A positive effect on the stock price can only be expected during the upcoming fiscal year, when the company might profit from stronger demand for their services due to an improving economic environment. Apart from that, the company might also be an attractive acquisition target for larger competitors as the largest shareholder, the Colruyt family, seems to be willing to sale their stake.
I invested in Dundee Corp. in February 2014. Part of my original investment thesis was that Dundee’s enterprise value is close to the value of its listed holdings. As a consequence, an investor was not paying for the company’s privately owned portfolio which added to more than half of Dundee Corp’s market value at that time.
The following table shows the changes in Dundee’s public listings over the last year:
The changes are significant due to a decline in the market values, but also due to a shift towards a larger allocation in privately owned investments. The most relevant change was the sale of almost all units in Dundee REIT and Dundee International REIT for gross proceeds of CAD 207 m. Consequently, listed holdings declined from almost 100% of enterprise value to only 65% and the corporate structure became more complex.
At the same time book value decreased from CAD 1.59 bn at the end of 2013 to CAD 1.35 bn at the end of 2014. The discount to NAV widened from 41% to 51%.
Dundee owns a diversified portfolio of “hard assets” including real estate (mostly Canadian residential and commercial developments), participations in oil and gas projects (the largest one in the republic of Chad), precious metals miners like Dundee Precious Metals and different agro business companies (the largest one being Blue Goose which produces organic meat and fish). In addition to that, the company owns a wide range of different assets like a conglomerate in South America, a biotech company which has a phase 3 product against the Alzheimer disease or an outsourcing company for the assembly of complex modules. Over the last 20 years, Dundee’s management was able to produce a number of successful ventures and generated enormous wealth for shareholders. I believe this will also be the case in the future.
The company is now also in the first steps of trying to repeat its past success with the creation of Dundee Wealth, which was sold to Bank Nova Scotia in 2011. As the non-compete arrangement has expired, Dundee is planning to establish to grow its asset management business. As a consequence, going forward the company will be divided into a merchant banking segment holding all the investments and an asset management segment providing services to clients.
In conclusion, the market seems to have a point in neglecting some of my quarterly underperformers (but not all of them). For me the question is whether operating problems will persist for a long time to come. Over the next weeks I plan to make some decisions with regard to this part of the portfolio.
Of course there have also been news with regard to the remaining part of the portfolio. However, as most of these news have been good ones and as I want to focus in my reports on the things which do not run so well, I decided to provide an update on the other investments of the portfolio at a later point in time and when necessary.
Q1 2015 Portfolio
1) incl dividends/interest and fx movements
2) Eredene Capital delisted in December 2014 from the AIM. I have valued the investment at cost representing a 50% discount to the company’s NAV. Eredene is currently in the process of selling its assets and distributing the net proceeds to shareholders.
Q1 2015 transactions
During the quarter I sold Telefonica Deutschland, accepted the tender offer by UMS, acquired four Italian real estate funds and started to accumulate positons in JZ Capital and Microwave Vision. I also received significant dividend payments in particular from my German and Italian real estate fund holdings. From the beginning of 2015 I have reduced the interest rate on cash from 100bps to 50 bps plus EONIA.
As always you can find an overview of the transactions taken place during the quarter below:
1) Including to dividen payments made last year which I forgot to count for.
2) Interest on cash is EONIA + 50 bps
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!
Below you can find an overview of the current portfolio: