Olesen Value Fund Q2 Letter To Investors
In the second quarter, the fund generated a return of -0.2%. The following table shows our historical returns after fees alongside those of global equity markets since the fund’s inception.
Olesen Value Fund: Sold DHT Holdings at 74% Gain Over One-Year Period
During April and early May, we sold our investment in DHT Holdings Inc (NYSE:DHT), locking in a 74% profit in just over one year. This is a shipping company headquartered in Norway that transports crude oil for customers around the world in its fleet of 10 oil tankers. I bought the stock at a price that was over 40% below liquidation value—and even cheaper compared to my estimate of the going concern value (based on my discounted cash flow valuation), which was also a lot cheaper than its competitors. In addition, the company’s balance sheet was stronger than most other shipping companies. In my opinion, the low stock price was mostly due to its small size/liquidity and lack of attention from the investment community.
Olesen Value Fund: Stock Surges Dramatically After Equity Offering
Following a large, low-priced equity offering to finance further vessel acquisitions (which destroyed shareholder value), the stock price actually increased dramatically, perhaps due to increased awareness, liquidity, as well as a temporary upsurge in industry profitability. At the same time, I reduced my estimate of intrinsic value a little, mostly because of the equity offering and my growing concerns about Chinese oil demand. As our shares reached their one-year holding period, I sold them, which will result in the lower tax rate for long-term (> 1 year) capital gains for those of the fund’s investors who are taxable in the U.S.
Olesen Value Fund: Accumulating Small, Well-Positioned European Company at 10x Trailing P/E
During the second quarter, we began accumulating shares in a small European company with an excellent position in the industry it operates in, which is consistently generating high margins and returns on capital. The stock trades at approx. 10x adjusted trailing earnings, which I think is too low for this above-average business. The true earnings have been obscured by non-cash write-downs and poor performance in a non-core business segment. I think this segment will be divested or curtailed, which should cause the market to better appreciate the value of the business and lead to a higher stock price. As we are still accumulating this investment, we have to keep its identity confidential for now.
Olesen Value Fund: Sold Bank of America at 97% Gain
We also sold our shares in Bank of America Corp (NYSE:BAC), which I first bought in late August 2011 at $7.87/share. At this price, the stock traded at a nearly 40% discount to tangible book value, even though the company had already taken very large write-downs for legal liabilities and loan loss provisions relating to the financial crisis that appeared to be getting close in magnitude to the likely ultimate losses the bank would incur in this regard, and the bank’s overall capitalization appeared to be adequate. In addition, trends in credit losses, real estate prices and economic conditions in the United States had already stabilized or begun to improve following the financial crisis in 2008-2009. Moreover, the company had just received an investment from Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B).
The company had performed very poorly during the financial crisis in 2008-2009, to a large extent due to its acquisition of Countrywide Financial Corp., which was a mortgage lender that employed very lax underwriting standards during the real estate boom in the United States. In August 2011 when I bought the stock, the bank had recently reached a settlement with the trustee for most of the faltered mortgage-backed securities it and Countrywide had issued and taken a very large write-down for legal costs. The market, however, was concerned about additional exposures, and during the general market panic that was caused by the European debt crisis as well as the downgrade by Standard & Poors of the U.S. government’s credit rating, the stock became especially unpopular.
This was basically a mediocre but improving company available at an exceptional price due to the extreme investor pessimism. We made a 97% gain on our initial investment in the stock (27% annualized return). After taking into account subsequent purchases and sales of the stock, and furthermore after adjusting the returns to approximately reflect the impact of this investment on the fund’s time-weighted returns, not cash flow-weighted returns, (i.e., adjusting for the capital contributions and withdrawals that occurred in the fund during the holding period of the investment), we earned a 28% adjusted IRR on this investment, compared to 23% for U.S. stocks and 19% for global stocks over the same time period. At our sale price, which was 12% above tangible book value, I think the stock was only moderately undervalued.
Olesen Value Fund: Captured a Favorable, Highly Asymmetric Capital Structure Arbitrage Opportunity
The fund undertook a so-called capital structure arbitrage during the quarter, which involves buying a security and selling short a different security issued by the same company. In this case, my analysis indicates that the gain on the short position will most likely fully offset the loss on the long position in the event the company becomes financially distressed. If the company survives, I think the gain on the long position could be many times greater than the loss on the short position. Given this highly favorable, asymmetric risk-reward profile, I think this is a very attractive position. Due to the difficulty of borrowing the securities for the short position, I cannot share the name of this company with you until after we have exited the position.
Olesen Value Fund: Sold Sysco, Earned 18% Adj. IRR
Near the end of the second quarter, we sold our entire investment in SYSCO Corporation (NYSE:SYY), which is the largest foodservice distributor in the U.S., providing an extremely wide range of food and related products to restaurants, schools, hospitals and other foodservice establishments. The company focuses mostly on small, independent restaurants, which are more lucrative for Sysco than large restaurant chains but probably also more challenging to serve. In addition, Sysco benefits from economies of scale, has generally been well-run, and has gained market share in almost every year since its IPO in 1970. It has much higher margins and return on capital than its competitors. The company operates in a stable, slow-growing industry and has a strong balance sheet.
When I first bought the stock 3 ½ years ago, it was trading around 14x trailing earnings. While this is not an especially low P/E multiple, I thought earnings would increase because of the inevitable eventual deceleration in food price inflation, improving economic conditions (especially employment), and a very ambitious operational efficiency improvement initiative. However, earnings have been disappointing in general, which appears to be mostly due to lacking results of the operational initiative, more competitive industry conditions, and possibly also subpar execution in general by management. Over time, I have become more concerned about competition, for example from warehouse clubs. I also think investors’ expectations of benefits from a pending merger with US Foods are likely too