Institutional Investors

A Reason To Sell


  • We view our current positioning favorably, and we expect double-digit average annual returns
  • Our WESCO International analysis was featured in Barron’s
  • We sold one business during July

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Q2 hedge fund letters, conference, scoops etc


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The S&P 500 is now up 11% since it hit a yearly low in April, when we wrote that we were “using this decline to enhance our portfolios by adding to existing positions and by swapping into new investment ideas.” We like our portfolio’s current prospects.

We think our basket of businesses is priced to compound 10% to 15% per year. Our companies trade in aggregate at a lower valuation, have higher underlying expected earnings growth, and generate higher returns on capital than the S&P 500 broad market portfolio. Our businesses are qualitatively superior with sustainable competitive advantages. Plus, we rest easy knowing that our investment process manages business, valuation, and economic cycle risk as we move into year ten of the economic expansion.

We continue to view many of our names as asymmetric (high upside potential, low downside risk) return opportunities. We highlighted Baker Hughes GE in our April letter, which has since risen 28% to $35 per share. We think it’s worth $41 to $44 per share. Recently, our truncated analysis on WESCO International was featured in Barron’s (see here). We believe WESCO represents a double-digit, multi-year compound return opportunity with limited downside. We think the company could be worth $85 per share in the next few years, barring an economic downturn.

Good money management isn’t just finding great investment ideas, but it’s also having a thoughtful approach for when to sell. Stericycle, a business we sold at the end of July, provides a window into how our ongoing research process is central to our sell discipline.

Stericycle offers medical, pharmaceutical, and hazardous waste management services and document and hard drive destruction services. Our original thesis was as follows: Stericycle is a high cash generative business with sticky customer relationships. While the company has found its way into headlines on more than one occasion over the last decade, we have reason to believe that better times lie ahead. The company is working through its small quantity “SQ” settlement and pricing reset, and its multi-year restructuring program should ultimately drive margin expansion. While debt levels are currently high, the business has a history of generating ample free cash flow that can be used to repay debt. The board is undergoing a much-needed reshuffling, bringing in fresh talent and views that bode well for future capital allocation and oversight. Under this thesis, we think the stock is worth $100 per share by 2020. And yet, we sold at $70 per share.

We’re usually more than willing to endure a lot of volatility for the potential for 15%+ compounded annual returns, but Stericycle’s debt profile disqualifies it from being a buy-and-wait position. Debt levels are high and are going to grow further with $275 million to $300 million in front-loaded restructuring expenses. Lenders have been flexible with debt covenants to date, but we’re not placing our faith in their continued acquiescence, while fundamentals deteriorate.

We owned Stericycle for five months and during that time the company reported its 2017 fourth quarter and its 2018 first quarter. Both reports showed additional margin pressures, signs of weakening cash flow, and declining earnings quality. As such, we exited the name at a small gain ahead of the company’s 2018 second quarter earnings release and conference call.

The company reported a mixed quarter and trimmed its full-year guidance. Without doubt, there is an element of luck in investment results, particularly over shorter time frames, and in the case of Stericycle our exit timing was fortunate as its stock dropped after quarterly results were announced. But luck didn’t drive our decision to sell. Our process did.

We listened to the new earnings calls, followed management Q&A, tracked company presentations at industry conferences, spoke to industry participants, studied the new SEC filings, and updated and stress-tested our financial model. That is, we put in the hard work to weave new information into our Stericycle investment mosaic, cumulating knowledge. We do this for all our holdings. And through that original research, we decided to exit the name and watch from the sidelines.

Mind you, our goal is to own a share of a company for many years, not months or quarters, as was the case for Stericycle. But our long-term orientation and willingness to bear volatility requires ongoing confirmation of our thesis. Alas, the two new quarters (and now third) didn’t and thus we sold.

Johnson Controls, J.P. Morgan, and Stericycle were our top three contributors during the month, up 12%, 11%, and 7%, respectively. There were no detractors, with all holdings posting positive returns during the month.

Thank you for your continued trust.

Alan R. Hartley, CFA

Article by Black Cyprus Capital


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