Kerrisdale Capital was light on the commentary explaining why they lost -5.4% in the second quarter, down -12.1% year to date although their short in DISH Network was part of the cause, as we reported recently. After a rousting string of consistent double digit profits since its founding in July of 2009, the long / short hedge fund has been coming up decidedly short as of late. What the hedge fund does like are shares of Breentag and Check Point Software, two new positions in its portfolio, according to a copy of the hedge fund’s second quarter investor letter which was reviewed by ValueWalk.
Since 2009 founding, Kerrisdale is up 1,152.3% compared to 164.5% for the S&P 500
Investors in Kerrisdale have a lot to be thankful for, the least of which is market beating performance and never having a losing year in the fund’s history. The fund has delivered 1,152.3% for investors since its founding, significantly higher than the 164.5% the S&P 500 has delivered over a similar period. Sure, there were hiccups in early 2014 and 2015, but they overcame them.
While 2016 is clearly deeper in the books, there is still time to rebound – and relative to past yearly performance routs when the fund was up 62.5% and 201.2% in 2010 and 2011 respectively, it is possible with significant positive volatility found in upside deviation the fund could turn 2016 around and maintain its string of yearly profitability.
To accomplish this task, Kerrisdale is looking towards chemicals and an enterprise software company.
Brenntag has a perception problem
Brenntag is the world’s largest chemical distributor and is currently having a perception problem. Investors are assigning the stock a historically low price earnings multiple after “a tumultuous trading year” when the stock was beaten down for resetting earnings expectations.
The stock is incorrectly perceived as being heavily involved in the “depressed energy markets,” but in reality upstream oil & gas only comprises 11% of Brenntag’s gross profits, the letter noted. The mis-perceptions don’t stop there.
The sharp reduction in North American Exploration and Production has in fact reduced BNR’s consolidated growth over the past three quarters, but resilient demand in other markets — from the pharmaceutical, coatings, personal care, and food markets – are pointing to “a growth inflection” in the second half of 2016.
In short, Brenntag might turn around its performance in the second half just like Kerrisdale hopes to do. Sahm Adrangi’s hedge fund thinks Brenntag is going to end 2016 with a bang, generating more than €900m of EBITDA. “Even within a secularly slow-growth world with 2% organic growth, Brenntag shares should attract an FCF multiple of 18-20x once year-over-year comparisons stabilize in H2 2016 – at that multiple, shares would be worth €65-70, representing a 40-50% premium to today.”
A similar turnaround in Kerrisdale’s performance similar to what is expected at Brenntag would be a welcome development. The stock is well positioned even during crisis. “The benefits of Brenntag’s diversification across geographies and industries were evident in the financial crisis of 2009 as gross profit declined by just 2%. If a similar scenario were to recur, Brenntag’s diverse customer base (Syngenta, Airbus, GSK, and Novartis) and leading competitive position should result in accelerated market share gains with only moderate pain to short-term EBITDA,” the letter said.
Check Point Software is being punished because it is not growing as fast as others
Like Brenntag, Check Point Software is one of those stocks that investors just seem to misunderstand, the runt of the litter that really has potential. The enterprise security software company, which serves Fortune 1000 clients and deploys thousands of firewall terminals in numerous geographies around the world, is Kerrisdale’s second new long exposure in the portfolio.
Check Point has delivered consistent growth over the last ten years, part of which is due to 85-90% customer retention rates. Strong growth and happy customers, however, have not led to the company being appreciated on Wall Street. The stock price has “stagnated” since late 2014, due in large part to market perception. The stagnation came “after the market pigeonholed CHKP as the slowest growth security stock in a rapidly growing sector.”
But the categorization was inaccurate.
Other high flying entrants into the space such as Palo Alto Networks and Fortinet have spent hundreds of millions of dollars to enter the space, promoting reseller incentives, hiring sales staff and stock grants only to establish footholds in smaller accounts. These efforts have resulted in 50% top-line growth, the Kerrisdale letter notes, leading to widespread support in the analyst community.
The problem is there is “little current free cash flow,” Kerrisdale says. “The market perceives this growth as coming at Check Point’s expense. We disagree with this bearish view and have found no evidence suggesting that Check Point has given up any material market share over the last few years.”
The stock is set to grow, with subscription revenues – and their prized reoccurring and predictable features — now outgrowing product revenues. This shift “leads to a more stable revenue stream without sacrificing cash flow generation,” the letter reasoned. “And yet the stock currently trades at multiples more closely associated with low-growth hardware businesses, a sentiment that we believe will dissipate in time.”
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