Emerging Value Capital Management letter to investors for the second quarter ended June 30, 2016.
Dear Partners and Shareholders,
For the second quarter of 2016, EVCM fund returned an estimated +0.1% net to investors. Stock markets worldwide were slightly up in the quarter with the All Country World Index (ACWI) and the HFRI Equity Hedge Index up +1.0% and up +1.4% respectively.
Since inception (10/15/2008), EVCM Fund returned an estimated +98.1% (net to investors). During this same time period the MSCI All Country World Index (ACWI) and the HFRI Equity Hedge Index returned approximately +85.3% and +42.4% respectively.
Emerging Value Capital Management Q2 Market & Portfolio Overview
The big story in Q2 was the “Brexit” – the surprise vote in the United Kingdom (UK) to leave the European Union (EU). The UK was always a somewhat reluctant member of the EU and even declined to adopt the Euro in place of the British Pound. Still, investors and markets were surprised by the vote’s outcome and responded negatively, with market declines of 5% – 15%. It remains unclear what the Brexit will look like, and when it will occur (with some analysts even doubting that it will really happen). Of even bigger concern is the possibility of a domino effect that will lead additional countries to also decide to leave the EU (Italy, France, Hungary, etc). One or more potentially messy “divorces” could have severe and unforeseen circumstances and could lead to a recession or worse.
Possible member country exits are only one of multiple severe problems faced by the EU. No less worrisome is the inability of most European countries to embrace capitalism and instead persist with economically stifling socialist policies. We can look at the rapid economic recovery of the US since the financial crisis of 2008 and compare it to the slow economic stagnation of most European countries to clearly see the vast economic benefits of capitalism over socialism. Additionally, Europe faces a migrant crisis of frightening proportion. Millions of refugees flood Europe every year overwhelming its capacity to absorb and integrate them. Completely open borders, poor screening, deficient tracking, and minimal cultural integration are subpar mechanisms for dealing with such a large influx of refugees.
Finally, Europe is facing a growing wave of terrorist attacks. Much of this is home grown terrorism inspired and aided by Islamic terrorist groups. As far as we can tell Europe’s response is mostly rhetoric with little concrete and effective action being taken to deal with these attacks and prevent the next attacks. Europe should learn from Israel as the world’s most effective model for fighting terrorism.
We remain pessimistic regarding Europe’s future and continue to have no investments in the continent. Given Europe’s multiple severe problems, we would expect to find European stocks trading at dirt cheap levels. Instead we find them to be only somewhat cheapish. We can find cheaper stocks in other, non-distressed, areas of the world such as the US, Israel and South Korea and prefer to invest our capital there.
While we have no direct investments in Europe and minimal indirect exposure, our portfolio did decline with the markets, particularly our financial stocks. We view these declines as short term market fluctuations (our stocks have already mostly recovered) and they are not a cause for concern.
We made few changes to our portfolio in Q2 because we like what we own and did not find anything better to buy. With very few exceptions, all companies in our portfolio are performing well, continuing to generate strong cash flows and increase intrinsic value. Since stock prices were mostly flat in Q2, this means that the stocks we own became cheaper (intrinsic value increased and stock prices remained constant). Over time, we expect this increase in value to be fully reflected in the price of our stocks. We continue to think that we have the highest quality portfolio in our history, that our companies trade at large (and growing) discounts to their intrinsic business values, and that we are invested in the best economies in the world (the US, South Korea, and Israel). Therefore, we remain optimistic about future performance.
In the next section, we will go into greater detail on some of these positions. For now, however, we think it is important to point out that our top 10 longs make up over 70% of our long exposure as we have increased the position sizes of our highest conviction ideas. As of quarter end, we were 83% long and 5% short. Our overall net exposure level of 78% reflects the compelling bargains we are finding in global stock markets combined with a reasonably sized cash position (17%) that we will utilize to take advantage of any downside volatility.
Our main contributors in Q2-2016
Despite our overall bullishness on our current portfolio, it remained flat and slightly underperformed the markets in the second quarter. Our main contributors to performance in the second quarter were Amerco, Isras Investments, Howard Hughes Corp and Samsung Electronics.
Operating under the UHAL brand, Amerco is the leader in the North America “do-it-yourself” moving and storage industry. The UHAL brand is by far the most well recognized and most dominant brand in the industry. With 20,000 locations and a fleet of over 200,000 moving trucks, Amerco has about 50% market share and is much larger than its main competitors Budget and Penske. Amerco enjoys multiple competitive advantages including: economies of scale, network effects, dominant brand recognition, cross selling between self-moving & self-storage, and high quality management.
Amerco has leveraged its domain position in moving truck rentals to expand into the self-storage segment. The company now owns over 38 million square feet of storage space at more than 1100 facilities. The self-storage segment is very synergetic with the self-moving segment since many people that move also require temporary storage space for their possessions. Amerco’s self-storage properties are a hidden asset. If the company spins them off into a REIT in the future, they could unlock shareholder value. Comparable self-storage companies trade around 14X revenues. This implies about $3B value for Amerco’s self-storage real estate – about 40% of the company’s current market cap.
Amerco’s self-moving segment is growing at over 8% per year and its self-storage segment is growing at about 5% per year. We expect these growth rates can be sustained for many years into the future since the company faces no material technological or competitive challenges. Amerco’s business lines are recession resistant since more people choose to self-move in difficult economic times. During the 2008 financial crisis, Amerco’s business was not materially affected. Valuation is also attractive, with Amerco trading at an estimates P/E ratio of 14, 8 times cash-flow from operations and 8 times Enterprise Value to EBITDA.
Isras is a leading real-estate development company with a valuable portfolio of retail, residential and office properties owned and under development all across Israel. Following an excellent 2015, Isras Investments reported a strong Q1-2106. The recent addition of Isras into the Tel-Aviv100 stock index also helped push up the stock price as investors became