KD - Greenlight Capital Q3 2023 Letter
2023-11-10 08:15:00 ET
Summary
- Green Light Capital is a privately owned hedge fund sponsor. The firm invests in the public equity and fixed income markets of the United States. It primarily invests in value.
- Greenlight Capital funds returned 12.9% in Q3 2023, outperforming the S&P 500 index.
- CONSOL Energy, Capri Holdings, and Black Knight were the top winners in the portfolio.
- The fund reduced gross exposure and expressed positive net exposure through the energy sector amid geopolitical tensions.
Dear Partner:
The Greenlight Capital funds (the “Partnerships”) returned 12.9% 1 in the third quarter of 2023, net of fees and expenses, and 27.7% for the first nine months of 2023, net of fees and expenses, compared to a -3.3% return and a 13.1% return for the S&P 500 index ( SP500 , SPX ), respectively.
It was a strong quarter for the Partnerships across the board. Despite broad market declines, we had substantial gains in our long portfolio. Our short portfolio declined a bit more than the market, and we also had a materially positive contribution from macro.
The material winners were CONSOL Energy ( CEIX ), Capri Holdings ( CPRI ), Black Knight (BKI), our short ‘Innovation’ basket, and a macro position that benefitted from both declining stock prices and higher long-term interest rates. Green Brick Partners ( GRBK ) was our only material loser during the quarter.
CEIX shares advanced from $67.81 to $104.91 during the quarter, despite no obvious fundamental developments. It was a favorable period for energy stocks (more on that below), and CEIX abandoned its dividend in order to increase its share repurchases. With earnings expected to be over $21 per share in 2023, it is proving to be a challenge for the stock to maintain such a measly P/E multiple in the face of such a large buyback. One can make a great return when a P/E multiple expands from 3x to 5x… might 8x be too much to hope for?
In August, CPRI agreed to be sold to Tapestry for $57 per share and we promptly exited the position. Beginning with the 2022 holiday season, CPRI’s fundamentals turned increasingly negative, and the company has since announced a string of earnings disappointments. When CPRI released poor fiscal year-end results in May, but insisted on maintaining overly optimistic guidance, we considered selling in frustration. With a forward bar that was set too high, we believed that further disappointments were likely. There was much hand wringing amongst investors and analysts about the earnings guidance of $6.40 per share. With the stock in the low $30s, why not lower the bar?
We reasoned that the most likely rationale for maintaining inflated guidance was to support a possible sale process. Based on that intuition, we decided to hang on to our shares and we are glad that we did. Over a 2½ year holding period, we achieved an 8% IRR, which feels excellent considering how far below our initial expectations the business performed.
As we expected, BKI completed its sale to Intercontinental Exchange ( ICE ) in September. The FTC ultimately allowed the deal to close after ICE announced its willingness to divest two of BKI’s underlying businesses. We exited the position with a nice gain over our 6- month holding period, as the shares advanced from our average entry of $58.56 to our average sale at $73.43.
Though we covered all of our other bubble baskets earlier in the year, we left our ‘Innovation’ short basket in place. It declined about 10% during the quarter.
In early August, we developed a macro thesis that long-term interest rates would continue rising and as a result the stock market would fall. We observed at the time that the derivatives markets implied that stocks and treasury bond prices would continue to exhibit their typical negative correlation. However, we believed that this correlation was reversing and implemented a position consistent with our thinking. As stocks and bonds both fell, we made multiples on our investment.
GRBK fell from $56.80 to $41.51 during the quarter. The company announced second quarter earnings of $1.63 per share, which far exceeded consensus estimates of $1.18 per share. Full-year estimates for 2023 and 2024 rose from $5.16 and $5.54 to $6.13 and $6.49, respectively. However, the market has become concerned about the impact of higher mortgage rates, and most homebuilding stocks reversed a portion of the gains achieved earlier this year.
We are effectively on a “buyers’ strike” again and did not establish any material long positions during the quarter. It’s a tricky time and we remain worried about the direction of the market. We have reduced our gross exposure from 191% to 160% in order to enable us to deploy capital into new ideas, when we eventually decide to take a more positive view… which brings us to geopolitics.
There is an old joke: A newscaster reports, ‘The Russians launched ICBMs at America this morning, causing the stock market to plunge, but it rebounded sharply in the afternoon on a rumor that the Fed might cut the discount rate.’
Investors have been conditioned to ignore geopolitical risk.
When Russia invaded Ukraine, the S&P 500 opened down about 2.4%. That was enough selling, as it finished the day up 1.5% and advanced another 2.2% the following day. After the Hamas terrorist attack in October, the S&P 500 opened down 0.5%, but finished up 0.6% before tacking on another 1.0% over the next two trading days.
Apparently, these days geopolitical risk presents itself as a small overnight sell-off creating an immediate buying opportunity.
As we look at the world, there appears to be a real fracture between the United States and a small group of countries that seem to be working together to replace the U.S. as the dominant global power. After Russia invaded Ukraine, we wrote in our 2022 first quarter letter that “there is a decent risk that Pax Americana has come to an end, along with the 13-year-old bull market.” In the year and a half since, the S&P 500 is down.
Our current working thesis is that the leaders of the countries that seek to displace the U.S. would prefer a different U.S. President. For example, Donald Trump says that he would end the war in Ukraine on his first day back in office. From Putin’s perspective, that would have to be welcome. It is also clear that Saudi Arabia’s Crown Prince does not like President Biden. Chinese leader Xi Jinping has refused to speak with or meet with President Biden for years, although efforts are being made for them to finally meet in November.
Perhaps the best way to influence the upcoming U.S. election is to create some combination of wars and recession. Come next summer, nothing would make President Biden less popular than multiple ongoing conflicts and $6 gas at the pump. Having sold down the Strategic Petroleum Reserve and having adopted a policy that discourages drilling for oil, the U.S. has left itself quite vulnerable to higher oil prices. Globally, storage is at a multi- year low.
Higher oil prices would squeeze the consumer and likely cause a recession. The resulting inflation would also put the Federal Reserve in the uncomfortable position of having to fight rising prices at a time of rising unemployment. This leaves the market outlook very concerning.
We are positioned accordingly. With our sale of CPRI, we have limited exposure to the U.S. consumer. Our positive net exposure is expressed almost entirely through the energy sector, and we have added a large macro position via futures and options that will benefit from much higher crude oil prices throughout 2024.
If we are right, current extreme levels of geopolitical tension will lead to lower stock prices over a timeframe that lasts more than a couple of hours. At that point, we intend to be positioned to buy beaten-down stocks and some truly distressed debt, should the opportunity present itself.
The complacent investor view that geopolitics should be ignored might be true, except for the times when it isn’t. We suspect we are in one of those times.
While we write these letters with an eye toward the markets, we also want to express our heartfelt empathy to those affected by the atrocious October 7 th Hamas terrorist attacks on Israel and those that feel unsafe in its aftermath. We continue to pray for peace. We view these global shocks with sadness but we invest based on the world as we see it, as opposed to how we wish it was.
On a more cheerful note, please save the date for our 28 th annual partner dinner, which will be held on Monday, January 22, 2024 here in New York City.
At quarter-end, the largest disclosed long positions in the Partnerships were Brighthouse Financial ( BHF ), CONSOL Energy ( CEIX ), Green Brick Partners, Kyndryl Holdings ( KD ) and Vitesco Technologies ( VTSCY ). The Partnerships had an average exposure of 94% long and 66% short.
“I think it’s wrong that only one company makes the game Monopoly.”
– Steven Wright
Best Regards,
Greenlight Capital, Inc.
Footnotes1 Source: Greenlight Capital. Please refer to information contained in the disclosures at the end of the letter. The information contained herein reflects the opinions, estimates and projections of Greenlight Capital, Inc. and its affiliates (collectively “Greenlight”) as of the date of publication, which are subject to change without notice at any time subsequent to the date of issue. Greenlight does not represent that any opinion, estimate or projection will be realized. All information provided is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. Greenlight has an economic interest in the price movement of the securities discussed in this letter, but Greenlight’s economic interest is subject to change without notice. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. GREENLIGHT® and GREENLIGHT CAPITAL, INC. with the star logo are registered trademarks of Greenlight Capital, Inc. or affiliated companies in the United States, European Union and other countries worldwide. All other trade names, trademarks and service marks herein are the property of their respective owners who retain all proprietary rights over their use. These materials are ( A ) confidential and may not be disclosed, distributed or reproduced without the prior written permission from of Greenlight, and ( B ) intended solely for the use of the person to whom the materials have been delivered by Greenlight. Unless otherwise noted, performance returns reflect the weighted average total returns, net of fees and expenses, for “New Issue Eligible” investors invested since inception in Greenlight Capital, L.P., Greenlight Capital Offshore Qualified, Ltd., and the dollar interests of Greenlight Capital Investors, LP and Greenlight Capital Offshore Investors, Ltd. (collectively, the “Partnerships”). Performance returns exclude the gold interests of Greenlight Capital Investors, LP and Greenlight Capital Offshore Investors, Ltd. The performance of the dollar interests and the gold interests have been different. Upon request, Greenlight will provide the specific performance of each type of interest to help investors understand these divergences over time. Combined performance of components of the Partnerships is model performance presented for illustrative purposes only and does not reflect the performance or risk profile of any individual fund. Model performance should not be considered an indicator of the future performance or risk of any investment. Actual performance of the funds, which is available upon request, may differ substantially from the model performance presented. Each Partnership’s returns are net of the modified high water mark incentive allocation of 10%. This is the allocation experienced by an investor whose capital account is below its modified high water mark. Investors whose capital accounts are not below their modified high water marks would experience different performance. An investor’s actual returns may differ from the returns presented due to several factors, including the timing of each investor’s capital activity and the applicable incentive allocation rate, which may be 10% or 20% depending on whether such investor is below such investor’s modified high water mark. All figures are unaudited. Greenlight does not undertake to update any information contained herein as a result of audit adjustments or other corrections. Past performance is not indicative of future results. Each investor will receive individual statements from the funds’ administrator showing actual returns. Reference to an index does not imply that the Partnerships will achieve returns, volatility or other results similar to the index. The total returns for the index do not reflect the deduction of any fees or expenses which would reduce returns. All exposure information is calculated on a delta-adjusted basis and excludes “macro” positions, which may include, but are not limited to, government debt, currencies, commodities, credit default swaps, interest rate swaps, volatility indexes, credit indexes and derivatives on any of these instruments. However, equity indexes and derivatives on such instruments are included in long/short exposure. The largest disclosed long positions represent individual issuers to which the Partnerships have the highest exposure. Greenlight, in its discretion and in the interest of investor protection, may exclude from this list any position that has not been disclosed but would otherwise be included, and instead include the Partnerships’ next largest position. All weighting, exposure, attribution and performance contribution information is inclusive of positions held both directly and indirectly through the master funds, reflects the weighted average of such figures for investments by Greenlight Capital, L.P., Greenlight Capital Offshore Qualified, Ltd., Greenlight Capital Investors, LP, and Greenlight Capital Offshore Investors, Ltd. (excluding gold interests), and is the result of classifications and assumptions made in the sole judgment of Greenlight. All exposure calculations include the impact of month-end redemptions and subscriptions as of the first day of the following month. Net performance contributions by attribution category apply an allocation of operating expenses, management fee and incentive allocation to the applicable gross contribution. These pro forma net contributions are shown for illustrative purposes only to meet regulatory requirements. Different assumptions than those made by Greenlight can result in different net performance contributions at the category level. A description of the calculation methodology is available upon request. Changes in quoted prices and market returns of publicly traded investments do not reflect the deduction of fees or expenses from the Partnerships. These fees and expenses are reflected in the net performance of the Partnerships. The fund terms, performance returns, and portfolio characteristics reflected in this document are not indicative of future returns or portfolio characteristics and do not modify the terms of the funds as detailed in each fund’s confidential offering memorandum. The specific investments identified and described are not representative of all the positions held, purchased or sold, and in the aggregate, the information may represent a small percentage of activity. It should not be assumed that any position identified has or will be profitable. There can be no guarantee that similar investment opportunities will be available in the future or that Greenlight will be able to exploit similar investment opportunities should they arise. The information presented is intended to provide insight into the noteworthy events, in the sole opinion of Greenlight, affecting the Partnerships. The opinions expressed represent the current, good faith views of Greenlight at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. THESE MATERIALS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY INTERESTS IN ANY FUND MANAGED BY GREENLIGHT OR ANY OF ITS AFFILIATES. SUCH AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY INTERESTS MAY ONLY BE MADE PURSUANT TO DEFINITIVE SUBSCRIPTION DOCUMENTS BETWEEN A FUND AND AN INVESTOR. |
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
For further details see:
Greenlight Capital Q3 2023 Letter