Barry Pasikov year-end letter to Hazelton Capital Partners.
Hazelton Capital Partners, LLC (the “Fund”) gained 12.1% from October 1, 2013 through December 31, 2013, increased 48.6% year-to-date, and has returned 88.7% since its inception in August 2009. By comparison, the S&P 500 gained 10.5% in the same quarter, increased 32.4% year-to-date and has returned 96.8% since the Fund’s inception.
Hazelton Capital: The Funds Performance – The Year in Review
Hazelton Capital Partners ended the 4th quarter with a portfolio of 18 positions, a cash level of 22% of assets under management, and averaged just over 25% in cash throughout the year. As of year end, The Fund’s top five portfolio holdings were: Western Digital (WDC), DreamWorks Animation (DWA), Xerox Corp (XRX), Northern Tier Energy LP (NTI) and Marvel Tech Group (MRVL). These top five holdings represent 35% of the Fund’s assets and accounted for over 50% of the years profits. Beginning in the 3rd and into the 4th quarter of 2013, Hazelton Capital Partners added five new positions to the portfolio. Northern Tier Energy, an oil refiner, was the biggest investment of the five. More capital was invested in the 4th quarter of 2013 than any other quarter during the year. It just so happens that more positions were sold in the 4th quarter than any other quarter of the year, as well. The purchases and sales were executed independent of one another.
Sears Hometown and Outlet Stores (SHOS) – Closed Position -15% Loss
Sears Hometown and Outlet Stores Inc (NASDAQ:SHOS) was spun off from Sears Holdings Corp (NASDAQ:SHLD) in October of 2012. The stores, primarily franchised or dealer operated, focus on selling home appliances, hardware, and lawn and garden equipment. Operating with of a much smaller footprint than its competitors, SHOS has the flexibility to open stores in large mall settings, community shopping centers, strip malls, as well as urban store fronts. Since most home appliances (Washer/Dryers, refrigerators, ovens, etc.) need to be delivered and installed, Sears Hometown and Outlet Stores is able to take advantage of the growing “showrooming” trend by only maintaining floor models. By ordering its appliance directly from Sears (SHLD), Sears Hometown and Outlet Stores is able to utilize Sears’ (SHLD) purchasing power (SHLD is one of the largest buyer of appliances in the US), as well as its delivery and installation infrastructure. Moreover, with Sears Hometown and Outlet Stores ability to leverage off of the “Sears” brand and marketing power, Hazelton Capital Partners felt that SHOS had an additional competitive edge to compete successfully against other appliance retailers, such as The Home Depot, Inc. (NYSE:HD), Lowe’s Companies, Inc. (NYSE:LOW) and Best Buy Co., Inc. (NYSE:BBY). Additionally, Hazelton Capital Partners believed a strengthening housing market would only add a tailwind to what has been a very challenging appliance retail market over the past couple of years. Recently, SHOS has been strategically opening new stores in close proximity to a Sears’ (SHLD) store that was in the process of being closed down in order to capture a customer base that might have otherwise been lost. The combination of Sears Hometown and Outlet stores competitive advantages, together with its favorable financials, led Hazelton Capital Partners to believe that SHOS would be a profitable investment.
Hazelton Capital Partners failed to fully understand that many of Sears Hometown and Outlet Stores Inc (NASDAQ:SHOS) expected competitive advantages from its close association with Sears (SHLD) were actually eroding. Sears (SHLD) originally began as a mail order catalog, but expanded its business and developed into a department store. Over time, Sears found its footing as a discount retailer and, until 1989, was the largest retailer in America. Today, Sears has been surpassed by companies, such as Wal-Mart Stores, Inc. (NYSE:WMT), Target Corporation (NYSE:TGT), Best Buy Co., Inc. (NYSE:BBY) and The Home Depot, Inc. (NYSE:HD), as it continues to spend little to no money on expanding or even maintaining its brand. Its stores are antiquated and run down, reflecting the community it serves. Customer service is non-existent and its merchandise is outdated. These factors have all had a negative impact on the company’s brand and strength within the retail market.
Initially, Sears Hometown and Outlet Stores Inc (NASDAQ:SHOS) appeared to be a smaller more maneuverable retail vessel that was tethered to Sears Holdings Corp (NASDAQ:SHLD)’s Titanic purchasing power, delivery infrastructure, marketing and brand prowess. But after further evaluation, it became clear that Sears (SHLD) brand erosion was negatively impacting Sears Hometown and Outlet Stores, as well. The question that Hazelton Capital Partners cannot fully answer is whether Sears’ (SHLD) purchasing power and delivery infrastructure will or has been negatively impacted. Realizing that Sears Hometown and Outlet Stores retailing strength and future is tethered to Sears (SHLD) did not provide Hazelton Capital Partners any solace, even as many smart investors consider Sears (SHLD) to be “unsinkable.” Hazelton Capital Partners decided to exit the position at a loss.
Northern Tier Energy – Current Holding
The United States oil refining industry is highly fragmented with approximately 140 refineries and a throughput of almost 18 million barrels per day (bpd). It is also highly concentrated with the top five refiners representing nearly 50% of the US total refining capability. Oil refiners generate profits by purchasing crude oil, processing it into petroleum products, such as gasoline, diesel fuel, jet fuel, heating oil and asphalt, and then selling those products into the retail or wholesale market. The difference between the price at which a refiner can purchase its crude oil, refine it and then sell the petroleum products is referred to as the company’s “crack spread.” The crack spread is directly correlated to a company’s profitability; the greater the crack spread, the greater the company’s profitability. Hazelton Capital Partners has generally shied away from the refining industry simply because there are too many factors beyond a company’s control (price of oil, cost of refining, the economy, and changes in consumer sentiment) that can negatively impact its margins. Add into the mix a large number of players, and you have the makings of an industry that will be driven by irrational behavior and little control over its destiny. But Northern Tier Energy is unique in its ability to maintain a strong profit margin by sourcing cheap crude oil and the niche market it services. Additionally, NTI’s corporate structure also plays a role in its competitive edge.
Northern Tier Energy is located in St. Paul, Minnesota and has a refining throughput of approximately 92,500 bpd. In refining, as in real estate, there are three things that matter: Location; location; location. St. Paul’s close proximity to North Dakota provides NTI the competitive advantage of sourcing its light sweet crude oil from the Bakken Shale, a growing source of domestic oil. At nearly 1 million bpd, the Bakken Shale represents over 10% of the US domestic oil production and has doubled its output since January of 2012. This rapid production growth is causing Bakken oil to sell at a discount to the West Texas Intermediate (WTI) benchmark, as the Bakken lacks the transportation infrastructure (rail and pipelines) to easily transport its oil to refiners. These factors benefit Northern Tier Energy, providing the company with the cheapest source of light sweet crude in the United States. Location also plays a role in the market that Northern Tier Energy