Commentary
Worst Performers
The three worst performers were Trigano, Serica Energy and Allegiant Travel. Serica Energy suffered following the release of the Labour government’s manifesto which showed a hardening of its position against UK oil and gas producers. Labour committed to a ‘proper windfall tax’ of 78% on ‘oil giants,’ which was not a surprise; however, they added an intention to eradicate loopholes which has been taken to mean scrapping capital allowances. It was this second announcement which came as a surprise and led to Serica, along with its partner Jersey Oil and Neo, to pause their investment in the new Buchan field.
In June, Serica announced that production was still expected to be over 40,000 barrels of oil equivalent (BOE) a day at an average cost of below $20 per BOE. Prices for oil and gas remain above $80 a barrel, implying a healthy profit before tax and, thanks to the tax losses inherited from the Tailwind acquisition, the company’s tax rate should be closer to 60% rather than the 78% headline rate. We therefore expect the company to generate more than its enterprise value back in free cash flow over the next few years. The company is also returning a large amount back to us through its dividend which is currently yielding 17%.
Allegiant Travel is suffering along with all the other low-cost airlines in the USA because of oversupply in the industry and rising cost pressures. Allegiant’s specific position is worsened by Boeing’s inability to deliver new planes, creating dual running costs; losses on the new hotel Sunseeker; and further pressure on yields and profitability from implementing a new pricing system.
Nevertheless, we expect Allegiant to return to above average margins going forward. First, some of the issues highlighted above are temporary: sunseeker losses, Boeing deliveries and costs associated with implementing new revenue management systems; excluding these items, Allegiant suggested that the airline operating margin was in the mid-teens, well above industry average. In addition, over the coming year the company expects utilisation to steadily improve back to pre-COVID levels helping increase revenue and reduce costs.
If it is successful in this execution, then the shares are extraordinarily cheap. Allegiant currently generates $2.5bn of revenue. Operating margins averaged 20% before COVID; even if they deliver just 15%, this implies around 3 times price to earnings compared to a long-term median of around 15 times.
Trigano, the European leader in motor homes, suffered along with other French businesses following the announcement of a snap election in France. The company updated the market on current trading which has remained strong with solid revenue and earnings growth; however, there were some signs of weakness in the outlook leading to the shares selling off. Trigano has a market capitalisation of just over €2bn, with net cash and is forecast to generate over €350m in profits this year.
Top performers
The best performers were Eurobank, Warsaw Stock Exchange and Pason Systems. Eurobank, received permission from the ECB to pay a dividend for the first time since 2008. The dividend was set at a yield of nearly 5%. It remains the best capitalised bank in Greece, earning high teens on equity and still trades below book value.
Warsaw Stock Exchange has seen solid growth in activity in the first quarter and announced a 10% increase in its dividend, increasing the yield to just over 6%. It remains one of the cheapest exchanges in the world despite having relatively immature and fast-growing capital markets.
Pason Systems announced results with revenue per rig rising 8% year on year as well as completing the acquisition of Intelligent Wellhead Systems (IWS). IWS will add a new growth opportunity that could be as large as the existing business. The shares are trading on 12 times earnings well below comparable data led businesses.
New Position
We initiated a small position in CuriosityStream. CuriosityStream is a global factual TV streaming company. The company was founded by John Hendricks (JH) who remains the Chairman and largest shareholder. JH founded the Discovery Channel in 1982 and ran it for over thirty years turning it into the largest factual media company in the world. He recognised the opportunity and potential threat to Discovery by the emergence of streaming over the internet, eventually leaving the company and setting up CuriosityStream.
CuriosityStream has had $300m invested in it to reach scale. The company now has over a million direct subscribers ($40m rev), 17,000 titles (10,000 of which were originally produced) and receives around $20m in revenue from licensing titles to other media platforms. After years of heavy losses due to high cost of acquiring subscribers and the need to get their content library to critical mass, the company has finally reached cash flow breakeven and expects to be cash flow positive from here. The company has initiated a dividend which amounts to a yield of 8% as well as a buyback of up to $4m (7% of market cap).
CuriosityStream has an enterprise value of just $30m ($60m market cap and $30m net cash) – a material discount to the invested capital. It is expecting to be on a free cashflow run rate of $8m by year end. It is probable there will be consolidation in the streaming sector in the years ahead and CuriosityStream would be an attractive target - its tax losses alone are worth considerably more than the current enterprise value.
Conclusion
In the long run our return should roughly be equal to earnings growth plus the dividend. As the chart below shows, earnings have grown over 350% (13% per year) since the end of 2011, substantially faster than the index. At eight times earnings, the strategy is the cheapest it has ever been, so it is perhaps not surprising that two thirds of portfolio companies have either bought back shares or have seen insider buying in the last year. The current upside to our target prices is over 110%.
Commentary
It was another poor quarter from a performance perspective with the strategy down 5% compared to a 3% fall in its benchmark. Smaller companies have dramatically underperformed larger ones year-to-date, with the MSCI World Small cap index 12% behind the MSCI World. Our exposure to smaller companies relative to our benchmark has continued to be the main driver behind our underperformance.
As the table below shows, MSCI world is trading on 22x earnings compared to 20x earnings for our SMID cap benchmark despite delivering less earnings growth over the last 12 years. The large cap index used to trade at a significant discount: in 2011 it was on 12x earnings compared to nearly 16x for the SMID cap index. The outperformance of larger companies has been entirely down to rerating over the period rather than higher growth in earnings.
Commentary
Worst Performers
The three worst performers were Trigano, Serica Energy and Allegiant Travel. Serica Energy suffered following the release of the Labour government’s manifesto which showed a hardening of its position against UK oil and gas producers. Labour committed to a ‘proper windfall tax’ of 78% on ‘oil giants,’ which was not a surprise; however, they added an intention to eradicate loopholes which has been taken to mean scrapping capital allowances. It was this second announcement which came as a surprise and led to Serica, along with its partner Jersey Oil and Neo, to pause their investment in the new Buchan field.
In June, Serica announced that production was still expected to be over 40,000 barrels of oil equivalent (BOE) a day at an average cost of below $20 per BOE. Prices for oil and gas remain above $80 a barrel, implying a healthy profit before tax and, thanks to the tax losses inherited from the Tailwind acquisition, the company’s tax rate should be closer to 60% rather than the 78% headline rate. We therefore expect the company to generate more than its enterprise value back in free cash flow over the next few years. The company is also returning a large amount back to us through its dividend which is currently yielding 17%.
Allegiant Travel is suffering along with all the other low-cost airlines in the USA because of oversupply in the industry and rising cost pressures. Allegiant’s specific position is worsened by Boeing’s inability to deliver new planes, creating dual running costs; losses on the new hotel Sunseeker; and further pressure on yields and profitability from implementing a new pricing system.
Nevertheless, we expect Allegiant to return to above average margins going forward. First, some of the issues highlighted above are temporary: sunseeker losses, Boeing deliveries and costs associated with implementing new revenue management systems; excluding these items, Allegiant suggested that the airline operating margin was in the mid-teens, well above industry average. In addition, over the coming year the company expects utilisation to steadily improve back to pre-COVID levels helping increase revenue and reduce costs.
If it is successful in this execution, then the shares are extraordinarily cheap. Allegiant currently generates $2.5bn of revenue. Operating margins averaged 20% before COVID; even if they deliver just 15%, this implies around 3 times price to earnings compared to a long-term median of around 15 times.
Trigano, the European leader in motor homes, suffered along with other French businesses following the announcement of a snap election in France. The company updated the market on current trading which has remained strong with solid revenue and earnings growth; however, there were some signs of weakness in the outlook leading to the shares selling off. Trigano has a market capitalisation of just over €2bn, with net cash and is forecast to generate over €350m in profits this year.
Top performers
The best performers were Eurobank, Warsaw Stock Exchange and Pason Systems. Eurobank, received permission from the ECB to pay a dividend for the first time since 2008. The dividend was set at a yield of nearly 5%. It remains the best capitalised bank in Greece, earning high teens on equity and still trades below book value.
Warsaw Stock Exchange has seen solid growth in activity in the first quarter and announced a 10% increase in its dividend, increasing the yield to just over 6%. It remains one of the cheapest exchanges in the world despite having relatively immature and fast-growing capital markets.
Pason Systems announced results with revenue per rig rising 8% year on year as well as completing the acquisition of Intelligent Wellhead Systems (IWS). IWS will add a new growth opportunity that could be as large as the existing business. The shares are trading on 12 times earnings well below comparable data led businesses.
New Position
We initiated a small position in CuriosityStream. CuriosityStream is a global factual TV streaming company. The company was founded by John Hendricks (JH) who remains the Chairman and largest shareholder. JH founded the Discovery Channel in 1982 and ran it for over thirty years turning it into the largest factual media company in the world. He recognised the opportunity and potential threat to Discovery by the emergence of streaming over the internet, eventually leaving the company and setting up CuriosityStream.
CuriosityStream has had $300m invested in it to reach scale. The company now has over a million direct subscribers ($40m rev), 17,000 titles (10,000 of which were originally produced) and receives around $20m in revenue from licensing titles to other media platforms. After years of heavy losses due to high cost of acquiring subscribers and the need to get their content library to critical mass, the company has finally reached cash flow breakeven and expects to be cash flow positive from here. The company has initiated a dividend which amounts to a yield of 8% as well as a buyback of up to $4m (7% of market cap).
CuriosityStream has an enterprise value of just $30m ($60m market cap and $30m net cash) – a material discount to the invested capital. It is expecting to be on a free cashflow run rate of $8m by year end. It is probable there will be consolidation in the streaming sector in the years ahead and CuriosityStream would be an attractive target - its tax losses alone are worth considerably more than the current enterprise value.
Conclusion
In the long run our return should roughly be equal to earnings growth plus the dividend. As the chart below shows, earnings have grown over 350% (13% per year) since the end of 2011, substantially faster than the index. At eight times earnings, the strategy is the cheapest it has ever been, so it is perhaps not surprising that two thirds of portfolio companies have either bought back shares or have seen insider buying in the last year. The current upside to our target prices is over 110%.
Commentary
Commentary
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Commentary