2020: Second Quarter Update

Portfolio Update
Please see the recent Portfolio Update piece, for some thoughts on the current portfolio and its structure. 

During the quarter OM made the following changes:
New Position:  Blockchain/Crypto (Thematic)
Added to: Shipping/Tankers (Dislocation), and Uranium (Dislocation)
Reduced: Greece (Dislocation), Brazil (Thematic), and Fourth Industrial Revolution (Thematic)
Exited: None.

Performance and Review
Following the dismal first quarter, equity markets surged during the second quarter with the S&P 500 posting its best performance since the fourth quarter of 1998!  OM’s portfolio sadly failed to join the Q2 party, rising a measly +0.7% and significantly underperforming both the S&P 500 Total Return (+20.5%) and the MSCI World (Total Return, Net Dividends; +19.4%).  For the year, this leaves the portfolio down -29.9% while the market indices are down mid-single digits (S& P 500: -3.1%, MSCI World: -5.8%).

Second Quarter Attribution

Our Man’s Q2 can largely be summed up as a significant negative contribution from Shipping/Tankers, a good contribution from the 4th Industrial Revolution theme and reasonable contributions elsewhere.

Shipping/Tankers (-853bps) were a significant drag on performance during the quarter, and for the first half of 2020.  While tanker rates are shaping up to have a stellar year and companies have performed exceptionally strongly, the stock price performance has been abysmal with most trading at or below the lows of March 2020!  

The bear case for tankers is centered on expectations of a prolonged period of rates at or below break-even stretching into early 2022.  These low rates will be driven by (i) demand for oil coming back slowly, (ii) floating storage - where oil was stored on tankers at sea - unwinding over a prolonged period now there is no contango, and (iii) ship owners will order more vessels.    Let’s be clear, these are not unreasonable or crazy fears especially for an industry that’s been in a 10-year bear market.   Certainly, it’s hard to argue that post-COVID demand is uncertain and that unwinding of floating storage will likely increase pressure on rates as more ships become available for transportation.  However, as noted in the recent portfolio update, OM believes that “if demand remains weak then pricing will not be as bad as investors fear”.  Why?  Firstly, supply is constrained; it’s one of the oldest fleets, with one of the smallest order books of the 2000s.  Secondly, the strong rates over the last 9 months coupled with the operational and financial leverage have created options for tanker companies to weather periods of low rates and reward shareholders.  This is best shown through a couple of examples.  

Teekay Tankers (TNK) came into Q4-2019 over-levered and with significant debt payments due within 12-24mos.   The exceptional rates of the last 9mos have allowed the company to (i) refinance 31 vessels pushing its debt maturities out 4 years, (ii) earn ~$7.50-8.00/share in 9 months (or almost two-thirds of its Q2-end market cap), which it wisely used to (iii) reduce its net debt by over 35%, and finally (iv) it leased some of its ships out for 6-24mos at strong rates, thereby reducing the break-even of its vessels in the spot-market to ~$10K per day.  The end result is a company vastly better poised to handle a period of lower rates, through both its financial position and its reduced sensitivity to those rates (due to the ships out on those 6-24month time charters).  OM rather hopes this starts to get reflected in stock prices, especially if/when tanker rates prove to be “not as bad” as investors fear.

On the other hand, Euronav (EURN) is the least levered and best managed of OM’s tanker names.  In 2020, it has so far returned 10% of its market cap in dividends and is happily purchasing its shares in the open market while they trade at a discount.

Given the rise in the markets, it’s not surprising that most of the portfolio were at least positive contributors.  The Idiosyncratic book led the way, aided by solid performance from the Funds (+238bps) which all rose 15-21% leaving 3 of the 4 broadly in line with the S&P 500.  GVAL, which systematically focuses on the most undervalued stocks in the most undervalued markets is lagging.   The position in Texas Pacific Land Trust (TPL, +130bps) rallied strongly, as oil prices rebounded and the company edged closer to converting to a corporation (from a land trust).

The Thematic book’s performance was driven by its 4th Industrial Revolution (+270bps) holdings, and especially the positions in Software-as-a-Service/Cloud software (WCLD).   With many of us working from home during the government lockdowns, these companies saw significant demand for the technological solutions.  Unfortunately, the median SaaS company now trades at 12x revenue, with many of the leaders trading at 20x revenue.  Though the group may continue to trade higher, OM isn’t comfortable adding at these valuations.   The rest of the thematic group performed reasonably win both India (+49bps) and Vietnam (+80bps) outpacing global markets during the quarter, though both lag meaningfully year-to-date.   Unfortunately, OM trimmed back the position in Brazil (+16bps) just before it rallied strongly.  The Blockchain/Crypto (-68bps) position was added late in the quarter.

Portfolio (as at 06/30/20 - all delta and leverage adjusted, as appropriate)

Dislocations: 38.5%
19.6% - Shipping/Tankers (STNG, DSSI, EURN, TNK and DHT)
14.5% - Uranium (URNM, CCJ and NXE)
4.3% - Greece (GREK & ALBKY)

Thematic: 18.1%
6.4% - Tech: 4th Industrial Revolution (JD & WCLD)
4.1% - Blockchain/Crypto (GBTC)
3.9% - Vietnam (VNM)
3.1% - India (INDA)
0.5% - Brazil (EWZ)

Technical: 0.0%
0.0% - OEW Technical positions (DDM, SSO, and QLD)

Idiosyncratic: 16.0%
15.4% - Funds (ARTTX, CWS, GVAL, and CAPE)
3.4% - Equities (TPL)

Shorts/Hedges: 0.0%

Cash: 24.6%

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc. 

Portfolio Update – Mid-2020

For those who follow markets, I’m sure you’ve seen numerous pieces trying to look at the dichotomy between the rallying stock market and the improving but still uncertain economy.  For those who don’t follow the markets closely, don’t worry this is not going to be one of those pieces!  Frankly, OM is more sanguine than most and there are reasonable arguments on both sides.  As a natural cynic, OM currently struggles to be too bullish but there are some broad themes that he’s comfortable with – thus this portfolio update will break the book down differently from normal.  As you might quickly surmise from the depth of the write-ups, OM is more inclined to add to those themes listed first over those listed later on.
 

Supply is Constrained (38.3% of the ptf)

This is the largest part of the portfolio, and it will likely be for some time.  In essence, OM has no great conviction in what demand will look like and so has instead concentrated much of the portfolio in areas where supply is constrained.  In the not-going-to-happen ideal world, if demand is good then the constrained supply will manifest itself in higher prices, and if demand remains weak then pricing will not be as bad as investors fear.  Supply has been constrained in these areas predominantly as they have been terrible, horrible, no good, very bad sectors (or are otherwise controversial) for a long time.  Clearly, OM thinks they are at an inflection point BUT until this is proven over time the good news will be discounted, the bad will be extrapolated and the stocks will be VERY volatile.  That unfortunately is the cost of investing here and so the ability to see the forest from the trees, the conviction to stomach that volatility, and the honesty to walk away if/when things change are what is going to matter.  Our Man added to all three positions during the quarter.

- Uranium (URNM, CCJ & NXE): 14.5% position
Our Man added significantly to his Uranium position multiple times during the quarter.  While there is a longer piece coming on Uranium, most of the key factors have been discussed before – the difference is that after numerous false starts, and aided by COVID-19, the time is finally right.  Today, there are clear tailwinds on both demand and supply sides.  Notably, there are changing attitudes in the West that will impact demand; even AOC has gone ‘no nuclear’ in the Green New Deal to ‘leaving the door open for nuclear’ in 18-months, and in a subtle shift 'green energy' has become 'clean energy' that includes nuclear.  On the supply-side, COVID-19’s impact means the two largest producers have largely shut-down their production creating a major short-term supply-demand imbalance and further highlighting the longer-term supply deficit.
 
- Shipping/Tankers (EURN, DSSI, STNG, DHT & TNK): 19.6% position
The tanker thesis can be summarized as the lowest ship order book in a decade+ combined with the oldest fleet in history: supply is constrained!  It is why things like the COSCO sanctions and the oil contango drove significant increases in shipping rates.  Unfortunately, while rates for 2020 are amongst the best in history, the stocks’ performance is not!  Investors expect rates to be fallow, falling beneath operating break-even, in the coming quarters as the floating storage unwinds and oil demand comes back slowly.  Unsurprisingly, OM doesn’t think that rates will be as bad…
 
- Blockchain/Cryptocurrency (GBTC): 4.1% position
OM will spare you a debate on bitcoin merits (or not), though as many of you know he owns cryptocurrency directly and has thus eschewed owning the less efficient ways of owning it in this portfolio.  Well that changed in Q2, as he held his nose and overlooked GBTC’s inefficient structure to start a position in Bitcoin.  Why?  Two reasons;
(i) COVID-19 launched a perfect storm of unprecedented fiscal stimulus and monetary easing coinciding with Bitcoin’s halving date (when supply became more constrained!).  Even the most ardent bitcoin believers couldn’t have dreamt of this!  It’s not a coincidence OM refreshed you on Plan B’s stock-to-flow model in the last Things from My Newsblur.
(ii) OM is old enough to remember when UK Chancellor Gordon Brown selling half the UK’s gold for $275 in 1999-2002 (it’s ~$18,000 today!) and the launch of the GLD ETF a couple of years later, which helped the gold price rise through consuming a large part of new gold supply during the 2000s.   After the collapse from the late-2017 highs reversed in late 2019, OM will be watching GBTC’s purchases of bitcoin to see if history rhymes.
 

 

Long-term looks good, short term questions (7.6% of the ptf)
OM’s positions in Vietnam, India and Brazil fall into this category.  The long-term thesis was covered last year; all three countries have a large millennial cohort that’s entering the workforce as the countries are economically liberalizing.   That’s historically been a great sign for a country’s economic growth and stock market performance.  The short-term questions all stem from COVID-19, the respective country’s handling of it and its broader impact.  While developed world nations have provided massive fiscal and monetary stimulus, those avenues are not as open in emerging markets.  The positions in India and especially Brazil were reduced, as it became clear that the two countries were struggling to deal with COVID-19.  Vietnam showed them how it should have been done.
 
- Vietnam (VNM): 3.9% position
- India (INDA): 3.1% position
- Brazil (EWZ): 0.5% position

 

The Department of the Near Future (6.4% of the ptf)
This has been the best performing part of the portfolio in 2020, with both the Software-as-a-Service (“SaaS”) exposure and JD.com up 50%+ through mid-year.  The thesis for SaaS is largely unchanged from when OM wrote it last year (part 1  and part 2) though the pandemic has likely hastened the transition to cloud services.  Unfortunately, this is largely priced in with the median SaaS company trading at ~12 x revenue, which is bubble territory!!
 
- SaaS (WCLD): 4.6% position
- JD.com (JD): 1.7% position

 

Permanent/Semi-Permanent Exposure (15.4% of the ptf)
An important part of investing is knowing yourself: OM tends to be cynical, which leads to him being underinvested.  The Funds book and the Technical book are two ways in which he tries to limit this investment flaw.  The Funds book is permanent exposure; it’s made up for 4 Funds, where OM either likes the thesis (if quantitatively driven) or the approach/manager (if qualitatively driven).  The positions aren’t traded and so provide consistent global market exposure.   The Technical book is based on OEW and is either invested or not, depending on the longer-term technical signals.
 
- Funds (ARTTX, CWS, CAPE, and GVAL): 15.4% position
- Technical: 0.0% position

 

Other/None of the Above (7.8% of the ptf)
Two positions don’t fit easily into any of the themes above. 
- Greece (GREK, and ALBKY): 4.3% position
The opposition New Democracy party swept to victory in Greece last year, in what OM was hoping would be the event that crystallized the dislocation in Greece.  Unfortunately, despite a strong economic plan and fruitful discussions with Europe, COVID-19 dealt the Mitsotakis government a poor hand. Greece has managed the crisis the best of any European country, with the Mitsotakis government showing the pragmatic approach OM had hoped for.  However, the lockdown has impacted economic progress, which has once more made Greece reliant on others and reduced investor interest.  As such, the Greece position is vastly smaller until there’s some clarity on the various European recovery mechanisms (which Greece will have to tap) and an increased sense of investor interst.
 
- Texas Pacific Land Trust (TPL): 3.4% position
Texas Pacific Land Trust is publicly traded land trust, with land in the Permian basin that benefits primarily from oil & gas royalties with a smaller (but growing) water business.  The trust was historically self-liquidating, using its excess cash to buy back shares, but has recently decided to convert itself to a C corporation

 

Cash (24.8% of the ptf)

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.