Coho Capital Management year-end letter to partners.
January 30, 2015
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Please find attached your year-end statement for 2014. Coho Capital returned 27.32% gross in 2014 and 21.35% net after fees and expenses. This compares to a return of 13.69% for the S&P 500 Index. According to the Wall Street Journal, 2014 represented the worst year for portfolio managers since 1997 with just 12% of managers outperforming the S&P 500.
Coho Capital’s performance would have qualified it as the best mutual fund in the country last year according to data published by the Wall Street Journal on diversified mutual funds. In relation to hedge funds, Coho Capital would have been considered the 20th best performing hedge fund in the world according to an annual list of the world’s top performing hedge funds (with at least $1 billion in assets) compiled by HSBC. This was a fall from our performance in 2013 (+42.4% net), good enough for 5th place on the list, and 2012 (+38% net) for 6th place on the list. Unlike many names on the hedge fund list we do not employ leverage. We are not interested in short-term results but believe the last three years underscore the efficacy of our approach.
We established two new positions in the second half of 2014; Cott Corporation (COT) and Graham Holdings (GHC).
Coho Capital: Cott Corporation (COT)
COT is the dominant producer of private label (non-branded) beverages in the United States, providing over 500 off-label brands to mass merchandise chains, convenience stores and grocers. The company possesses a 60% share of the private label carbonated soft drink (CSD) market and a 50% share of the private label juice market. In addition, COT engages in contract manufacturing and owns the international rights to RC Cola with concentrate sales in over 50 countries. Anyone who has researched Coke understands how compelling the economics of concentrate sales can be.
Despite being in a commodity like market with little pricing power, COT is a competitively advantaged business. The company has one of the broadest distribution networks in the United States encompassing 120 distribution centers and 34 manufacturing facilities. The density and breadth of COT’s distribution network results in greater proximity to its customers, enabling the company to provide superior customer service and lower freight costs than competitors. Further, COT’s scale advantage leads to higher inventory turnover allowing the company to more efficiently deploy its assets.
The economics of scale distribution can be compelling for markets where transport costs are significant. Examples include Sysco in the restaurant servicing space and Cintas in the corporate uniform rental market. Market leaders pass on a portion of their superior economics to their customer base which perpetuates and amplifies their advantages relative to competitors. In COT’s case, it is the only private label beverage company capable of servicing national retailers and is the low cost provider by an order of magnitude.
To give one example of COT’s competitively entrenched position, consider that when Walmart attempted to dual source CSD from another supplier in 2009 it was unsuccessful. Most companies that distribute through Wal-Mart hold little to no bargaining power. However, due to its dominant distribution network within the private label beverage space, COT has a seat at the bargaining table.
While COT’s private label business is not poised for rapid growth, it is a stable business that is highly cash generative. Further, deflation in raw material inputs and lower gas prices should provide a significant tailwind for earnings over the next 12-18 months.
We have followed COT for years due to its stable free cash flows and competitively entrenched market position. Despite the merits of its business model we hesitated to become share-holders due to the company’s reliance on carbonated soft drinks, an industry which we believe faces long-term challenges in demand growth. Overall soft drink volumes have fallen for nine straight years. As consumers have grown more health-conscious they have shifted their beverage preferences from soda to water, ready to drink teas, and energy drinks.
To counter this trend, COT announced a transformational acquisition last November in which the company paid $1.3 billion dollars to acquire DS Services. DS Services is a leading provider of office water delivery services in the US with a 30% market share. Market dynamics are attractive with DS Services and its largest competitor Nestle controlling 60% of the market. The rest of the market is made up of various mom and pop outfits, which face increasingly poor economic returns due to a lack of scale in a consolidating market. This provides DS Services a runway for future growth as it is well positioned to be a primary participant in the roll-up of smaller players.
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