Leon Cooperman’s Omega Advisors had a rough year, losing 4.2% in the fourth quarter and losing 2.8% for the full year while the S&P 500 was up more than 13%, but even that overstates the performance for most of their investors because it was calculated for general partners who don’t pay a management fee, while investors pay either a 1% or 1.5% management fee depending on when they started investing (no one is paying performance based fees this year). The problem is that, like plenty other hedge funds, Omega didn’t have any big winners but they suffered serious losses when oil tanked.
“Our 2014 performance was embarrassing and we failed to deliver acceptable returns. But while we clearly lost the sprint, we are confident that we will continue to win the marathon and provide attractive investment results over a relevant investment time-horizon,” Cooperman writes in the letter to investors reviewed by ValueWalk.
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S&P 500 earnings driven by megacaps
Cooperman points out that just ten stocks, making up 13.6% of the S&P 500 by market weight, contributed 33.6% of S&P 500 price growth. As foreign funds flowed in from investors looking for easy exposure to US equities, and other investors uncertain about the strength of the US recovery looked for ‘safe’ stocks, megacaps outperformed the rest of the market and PE dispersion remained incredibly low (though still up from 2013). This made for a difficult environment for stock pickers like Cooperman.
By the time PE dispersion started to grow again, Omega Advisors’ overweight exposure to the energy sector proved to be a major liability. Cooperman has trimmed energy exposure, but he has kept some exposure so that the fund can benefit from oil’s rebound whenever that might be.
“Clearly, we missed the mark with our energy call. Our supply/demand assessment did not signal the extent of the oil price correction,” he writes. “While we have, as noted, reduced our energy exposure, we still have a low-teens representation because we believe that at current levels, our energy names offer exceptionally good value.”
Omega Advisors’ top positions
In addition to breaking returns down by sector, you can see the impact that energy stocks had on Omega Advisors by looking at the biggest detractors in the fourth quarter. Of the ten worst performers, the eight energy companies can account for the entire loss for the quarter, implying that if we hadn’t had an oil shock Cooperman might have written a very different letter. Sprint and Monitise (which Cooperman has been championing all year long) were the biggest full-year losses for the firm.
As of the end of 2014, Omega Advisors had 74% gross exposure to US equities (and equity equivalents) and 9% gross exposure to non-US equities. It’s top 25 positions, which account for 49% of the portfolio, are Actavis Plc, Advance Purchase, Aercap Holdings NV, American International Group, Atlas Energy, Atlas Pipeline Partners Lp, Caesars Entertainment Corp., Capricorn Healtcare, Chimera Investment Corp., Citigroup, Dish Network Corp., E*Trade Financial Corp., eBay, First Data Corp., Harbinger Group, HCA Holdings, Kinder Morgan, McKesson Corp., Motorola Solutions, Navient Corp., Sirius XM Holdings, SunEdison, Telenet Group Holding NV, Tribune Media Co., and United Continental Holdings.
Cooperman explains his new investment in Gilead Sciences
Cooperman also mentioned that he has taken on two “new positions”, Gilead Sciences and Shire, and he gave a detailed explanation for the investment in Gilead (maybe we’ll hear about Shire in a future letter). First, Gilead Sciences is trading at nearly a 50% discount to its large-cap biotech peers, 10x 2015 EPS and less than 9x 2016 EPS by Cooperman’s estimate, and he expects it to generate $50 billion in free cash flow over the next three years with an underlevered balance sheet. So management has plenty of capital to work with.
More importantly, Cooperman says that Gilead has a proven track record of making smart investments, including the controversial $11 billion purchase of Pharmasset in 2011 which has made Gilead a market leader in treating Hep-C in addition to its strong position in HIV treatments.
“With $12B in Hep C sales in the first full year on the market, Gilead’s acquisition of Pharmasset was accomplished for less than 1x sales. Clearly, this is a management team that knows how to deploy its capital to create considerable value,” Cooperman writes.
Right now the stock price is depressed because AbbVie has gained FDA approval for its own Hep C treatment, but Cooperman says that the size of the discounts that Gilead is offering to retain market share is smaller than what’s been reported in the media, and that it’s lower pill burden (one per day versus 4-6 per day) makes it more cost effective because patient compliance is significantly higher.
Cooperman sees further upside in future treatments for liver disease and Hepatitis B currently under development.
Specfically, Omega says:
Given the near-trough forward P/E multiple, and based on our DCF analysis that conservatively assumes no pipeline contribution and meaningful erosion of core franchises, we believe downside is limited from current levels. At the same time, we see ~40% upside potential over the next 12 months, driven by a modest normalization of the multiple to 12x (which could prove low in light of 3-year forward, high-single-digit revenue and mid-teens eps growth outlooks) applied to our earnings estimates that assume continued growth of key on-market products and reasonable capital deployment. That implies a robust 4:1 risk/reward from current levels.
Lee Cooperman of Omega Advisors declined to comment on the letter.