CA - Black Bear Value Partners Q3 2023 Letter
2023-10-12 05:30:00 ET
Summary
- Black Bear Value Fund, LP is an opportunistic, concentrated and fundamental value investment partnership.
- Black Bear Value Fund returned +7.3% in September and is +26.4% YTD, outperforming the S&P 500.
- The fund remains focused on a few core areas of investment: energy/commodities, homebuilding, and auto dealers.
- The fund has a significant short position in credit instruments and companies with a need to refinance/depend on capital markets.
“If you think nobody cares if you’re alive, try missing a couple car payments.”- Earl Wilson
To My Partners and Friends:
- Black Bear Value Fund, LP (the “Fund”) returned +7.3% in September and is +26.4% YTD.
- The S&P 500 returned -4.8% in September and +13.1% YTD.
- The HFRI Index returned +8.8% YTD thru August (Sep numbers N/A).
- We do not seek to mimic the returns of the S&P 500 and there will be variances in our performance.
| Note: Additional historical performance can be found on our tear-sheet. |
While our portfolio has been performing well, we must remember that returns can be lumpy, and we will encounter periods of underperformance as our portfolio does not resemble the broader indices. Having long-term LP’s and long-term capital is a competitive advantage that allows us to worry less about short-term noise. This is a core business principle for Black Bear and one that will continue to serve us well in the coming years.
In our Q2 letter we quoted George Carlin when he said “One tequila, two tequila, three tequila…. FLOOR.” As discussed, it seemed that the bar was open with animal spirits alive and well, providing us an opportunity to add to our short positions as excitement returned to broader markets. The rapid negative change in investor sentiment is quite a sight to behold as some element of fear/apprehension is beginning to percolate among investors/speculators.
One of the benefits of having a concentrated portfolio is not needing to have an opinion on too many things. People often think investing is the act of having many opinions. We do not subscribe to this belief and in a market that, on the whole, seems relatively expensive, we have remained focused on a few core areas of investment: energy/commodities, homebuilding, and auto dealers. These themes have and continue to dominate our portfolio. Despite the increase in some of their prices, our investments remain very cheap, especially considering inflationary risks. Our businesses can weather inevitable tough times and take advantage while weaker/more leveraged competition struggles.
I want to caution our LP’s that while I like how we are positioned, our returns of late are unusual. Things will not always go our way and we need to remind ourselves that short-term pain can lead to long-term gain. We continue to look for quality companies, run by ethical management who think like owners, at fair to cheap prices. In the absence of those opportunities, we will hold cash and not reach. Patience has its virtues if you can move decisively when the fat pitches come.
Short Credit Revisited
We remain short credit as spreads remain tight. As corporate profit margins compress, I expect weakening credit fundamentals to result in additional spread widening to compensate for the eventual corporate defaults.
From 2003-2007 borrowers, en masse, elected to borrow money via mortgages with no money down and/or teaser interest rates. These were 0-2% mortgage rates that would keep payments low for the borrower. For a time, there was a panic about the great “ARM Reset” (this was the risk of adjustable-rate mortgages increasing to market rates). As we all know, the mortgage debt increased, and ARM resets were the least of our concerns as the overall debt pile became unsustainable . It turns out that even at 0% interest rates…if you borrow money, you eventually need to pay it back. It gives me pause when contemplating the health and direction of both our sovereign and corporate debt.
For over a decade the government (and many companies) have been paying teaser rates on an ever-increasing pile of debt, funding all sorts of fiscal adventures, some warranted and many extraneous. Now debt is at alltime highs, the teaser rates are expiring, and we need to refinance at MUCH higher rates. Concurrently the Fed is no longer buying the debt and it seems China, among others, is taking a breather too. I wonder…who is the marginal buyer of US debt and what will it cost? What about corporate debt which is trading at average to below-average spreads? I’d be lying if I had the answers…but the risk is real and is one of the reasons we have a significant short position in credit instruments and companies with a need to refinance/depend on capital markets.
Top 5 Businesses We Own Asbury Group ( ABG )
Asbury Group recently agreed to acquire the Jim Koons Automotive Companies in the largest auto retail acquisition since 2021. They will be taking on some leverage to consummate the acquisition. Asbury has successfully integrated past acquisitions and has a good track record of deleveraging the company. Longer term, this is an accretive deal and raises our “normal” free-cash flow per share by $5 to a range of $30-$40. At quarter end pricing this implies a 13-17% annual yield.
Asbury Group operates auto dealerships across the United States. While much attention is paid to the number of cars sold, the strength of the model comes from the back of the house in parts and services where more than 50% of the profits come from. We are exiting a period of high margins on new and used car sales. Shortages of inventory have allowed dealers to make record profits when selling a car. As inventories normalize and interest rates rise, I fully expect the dealers to make less profit (called the GPU) when selling a car. Car prices cannot go up ad-infinitum and at some point, there will be buyer pushback.
Less discussed is while profits per car are at all-time highs, the volumes sold have mirrored prior recessions. My expectation is that dealers will likely make less per car but will mitigate some of that pressure by selling more cars, especially used vehicles, as prices drop.
When an auto dealer sells a car to a consumer, they capture both the trade-in (inventory to sell) and the relationship for parts and services. It is a razor-razorblade model in a highly fragmented industry (many dealerships are owned privately by families). The large dealer groups have transitioned to an omni-channel model where much of the selling/pre-buy activity can be done online reducing the need for headcount and making the transaction smoother for their customers. The lower operating costs of the business are not appreciated by the market. They are appreciated by us and the management teams as most dealers, including ABG, have been buying in lots of stock with their free-cash flow.
Builders FirstSource ( BLDR )
BLDR is a manufacturer and supplier of building materials with a focus on residential construction. Historically this business was cyclical with minimal pricing power as the primary products sold were lumber and other non-value-add housing materials. Since the GFC, BLDR has focused on growing their value-add business that is now 40%+ of the topline. The company has modest leverage and has been using their abundant free-cash-flow to buy in over 30% of the stock in the last 18 months.
While mortgage rates are higher, they are not unusual versus history. The low rates of the last 5-10 years are the outlier. We have a structural shortage of housing in the USA. With existing homeowners locked into lowrate mortgages, the aspiring homeowner may increasingly need to find a home from a homebuilder. The next 6-12 months could be rocky as people adjust to the increase in pricing and rates. Eventually the housing market should adjust to the new normal (or rates could go down).
The company has realized sustained higher gross margins as they have gained scale. I am now giving them credit for some increased margin and raised my normalized free-cash-flow per share to $13-$17 per year. At quarter end pricing of ~$124 that implies a free-cash-flow yield of 10-14%.
CONSOL Energy ( CEIX ) / Paramount Resources ( PRMRF , POU.TO )
We have a large investment across the energy & commodity spaces. The thesis is simple…we haven’t developed enough energy or commodity resources to satisfy the near- and medium-term needs of the world as well as provide for a renewable/less-carbon intensive future.
CONSOL Energy is an American energy company focused on the coal sector. The business has undergone a shift from being a majority producer of coal for domestic energy purposes to an export-driven producer of coal for non-power generation purposes. Over the last few years, the Company has delevered to a near-zero netdebt position and is trading at a 25%+ unlevered free cash flow. While there is a negative stigma associated with coal (and some deserved) there are parts of the world that have limited energy alternatives and will require coal supply over the coming years. I expect the company to commit a large amount of the free-cashflow to buying in cheap stock and the per share intrinsic value to grow substantially over the next 3 years.
Paramount is an ENP (exploration and production) in the energy space. It has no debt and ~$580MM in cash/securities (14% of the mkt cap). Management is fully aligned with us as they own 47% of the Company.
Over the next 2 years the company should generate ~9-10% in annual free-cash flow presuming fairly bearish energy prices. I tend to believe this is on the lower end as China reopens, and the lack of worldwide energy developments becomes more pronounced.
Warrior Met ( HCC )
Warrior Met produces met coal which is used for steelmaking. They are a largely export driven producer (97%) with a large cost advantage as they can ship to Europe and South America in ~2 weeks versus Australian competition of ~5 weeks.
Some rough math on HCC (quarter-end price of $49 and market cap of ~$2.6BB and $0 net debt)
- They have a current project coming online in 3 years with an estimated value of $1BB or $19 per share per management.
- I use a more modest discount rate and operating cash flow as the future is tough to know and get to $300-$500MM or $6-$9 per share.
- Excess cash of $5 per share
- The existing business requires $100MM in capex and generates midcycle operating cash flow of $500MM.... resulting in ~$8 in FCF per share. Some believe this number is closer to $800-$900MM per year.
- Let’s presume non-heroic FCF yield of 15-20% on $500MM = $40-$53 per share
- New project of $6/$9 + Excess Cash of $5 + Operating business $40/$53 per share = $51-$67 per share vs. current price of $49
Note the above is a very rough calculation and shows the wide margin of safety baked in the price. We may decide the operating business is worth more than a 15-20% yield…. but for now, we do not have to make any big leaps with respect to valuation.
The Company has not been active in the share repurchase market to preserve their NOL’s (avoid triggering a change in control). As the NOL’s are used up in the coming 12 months they should be able to aggressively repurchase stock and significantly increase the intrinsic value per share.
Wrapping Up
We will continue owning durable businesses that can benefit through a tough economic cycle. Most of our companies have little to no debt and can be opportunistic in either buying their own shares or distressed competitors in the event of market tumult. While I do not root for bad economic outcomes, we do prepare for them.
Thank you for your trust and support.
Adam Schwartz, Black Bear Value Partners, LP
| THIS DOCUMENT IS NOT AN OFFER OF, OR THE SOLICITATION OF AN OFFER TO BUY, INTERESTS IN BLACK BEAR VALUE PARTNERS, LP (THE “FUND”). AN OFFERING OF INTERESTS WILL BE MADE ONLY BY MEANS OF THE FUND’S CONFIDENTIAL PRIVATE OFFERING MEMORANDUM (THE “MEMORANDUM”) AND ONLY TO SOPHISTICATED INVESTORS IN JURISDICTIONS WHERE PERMITTED BY LAW. This document is confidential and for sole use of the recipient. It is intended for informational purposes only and should be used only by sophisticated investors who are knowledgeable of the risks involved. No portion of this material may be reproduced, copied, distributed, modified or made available to others without the express written consent of Black Bear Value Partners, LP (“Black Bear”). This material is not meant as a general guide to investing, or as a source of any specific investment recommendation, and makes no implied or express recommendations concerning the matter in which any accounts should or would be handled. The returns listed in this letter reflect the unaudited and estimated returns for the Fund for the periods stated herein and are net of fees and expenses, unless stated otherwise. Black Bear currently pays certain fund expenses, but may, at any time, in its sole discretion, charge such expenses to the Fund. Please note that net returns presented reflect the returns of the Fund assuming an investor “since inception,” with no subsequent capital contributions or withdrawals. You should understand that these returns are not necessarily reflective of your net returns in the Fund, and you should follow-up with Black Bear if you have any questions about the returns presented herein. An investment in the Fund is speculative and involves a high degree of risk. Black Bear is a newly formed entity with limited operating history and employs certain trading techniques, such as short selling and the use of leverage, which may increase the risk of investment loss. As a result, the Fund’s performance may be volatile, and an investor could lose all or a substantial amount of his or her investment. There can be no assurances that the Fund will have a return on invested capital similar to the returns of other accounts managed by Adam Schwartz due to differences in investment policies, economic conditions, regulatory climate, portfolio size, leverage and expenses. Past performance is not a guarantee of, and is not necessarily indicative of, future results. The Fund’s investment program involves substantial risk, including the loss of principal, and no assurance can be given that the Fund’s investment objectives will be achieved. The Fund will also have substantial limitations on investors’ ability to withdraw or transfer their interests therein, and no secondary market for the Fund’s interests exists or is expected to develop. Finally, the Fund’s fees and expenses may offset trading profits. All of these risks, and other important risks, are described in detail in the Fund’s Memorandum. Prospective investors are strongly urged to review the Memorandum carefully and consult with their own financial, legal and tax advisers before investing. The development of an investment strategy, portfolio construction guidelines and risk management techniques for the Fund is an ongoing process. The strategies, techniques and methods described herein will therefore be modified by Black Bear from time to time and over time. Nothing in this presentation shall in any way be deemed to limit the strategies, techniques, methods or processes which Black Bear may adopt for the Fund, the factors that Black Bear may take into account in analyzing investments for the Fund or the securities in which the Fund may invest. Depending on conditions and trends in securities markets and the economy generally, Black Bear may pursue other objectives, or employ other strategies, techniques, methods or processes and/or invest in different types of securities, in each case, that it considers appropriate and in the best interest of the Fund without notice to, or the consent of, investors. Performance returns compared against benchmark indices are provided to allow for certain comparisons of Black Bear’s performance to that of well-known and widely-recognized indices. Such information is included to show the general trend in the markets during the periods indicated and is not intended to imply that the holdings of any of the applicable accounts were similar to an index, either in composition or risk profile. The indices represented herein are the S&P 500 and the HFRI EH: Fundamental Value Index (“HFRI EH FVI”). The S&P 500 is a free-float weighted/capitalization-weighted stock market equity index maintained by S&P Dow Jones Indices, which tracks the performance of 500 large companies listed on U.S. stock exchanges. The HFRI EH FVI reflects fundamental value strategies which employ investment processes designed to identify attractive opportunities in securities of companies which trade a valuation metrics by which the manager determines them to be inexpensive and undervalued when compared with relevant benchmarks. This presentation contains certain forward looking statements. Such statements are subject to a number of assumptions, risks and uncertainties which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward-looking statements and projections. Prospective investors are cautioned not to invest based on these forward-looking statements. Furthermore, many statements in this presentation are the subjective views of Black Bear, and other reasonable persons may have differing views. Unless it is unequivocally a statement of fact, any statement herein (even if not specifically qualified as an opinion (i.e., with language such as “in the opinion of” or “we believe that”)) should nevertheless be understood and interpreted as an opinion with which reasonable persons may disagree, and not as a material statement of fact that can be clearly substantiated. The information in this presentation is current as of the date listed on the cover page and is subject to change or amendment. The delivery of this presentation at any time does not imply that the information contained herein is correct at any time subsequent to such date. Certain information contained herein has been supplied to Black Bear by outside sources. While Black Bear believes such sources are reliable, it cannot guarantee the accuracy or completeness of any such information. This Presentation has not been approved by the U.S. Securities and Exchange Commission (the “SEC”) or any other regulatory authority or securities commission. This Presentation does not constitute an offer of interests in the Fund to investors domiciled or with a registered office in the European Economic Area (“EEA”). None of the Fund, Black Bear or any of their respective affiliates currently intends to engage in any marketing (as defined in the Alternative Investment Fund Managers Directive) in the EEA with respect to interests in the Fund. Receipt of this investor presentation by an EEA investor is solely in response to a request for information about the Fund which was initiated by such investor. Any other receipt of this investor presentation is in error and the recipient thereof shall immediately return to the Fund, or destroy, this investor presentation without any use, dissemination, distribution or copying of the information set forth herein. |
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Black Bear Value Partners Q3 2023 Letter