Hazelton Capital Partners’ letter to partners for the first quarter ended March 31, 2015.
To: Hazelton Capital Partners, LLC
From: Barry Pasikov, Managing Member
Date: April 23, 2015
Re: 1st Quarter 2015 Letter to Investors
Hazelton Capital Partners, LLC (the “Fund”) declined 0.25% from January 1, 2015 through March 31, 2015, and has returned 85% since its inception in August 2009. By comparison, the S&P 500 gained 0.95% in the same quarter, and has returned 127% since the Fund’s inception.
Hazelton Capital Partners Performance – The Quarter in Review
Hazelton Capital Partners ended the 1st quarter with a portfolio of 17 equity positions and a cash level equivalent to 17% of assets under management. The Fund’s top five portfolio holdings, which are equal to 37% of the Fund’s net assets, are: Western Digital, DreamWorks Animation, Apple, Tesco (TSCDY), and Northern Tier Energy (NTI).
Hazelton Capital Partners: Much to Do About Nothing – So Far
During the 1st quarter of 2015, there were a total of 20 days (1/3 of the quarter) in which the S&P 500 index had a daily gain or loss that was greater than 1%. In fact, some have since rebranded the Standard & Poor’s 500 as the Schizophrenic & bi-Polar 500. By way of comparison, for all of 2014, there were a total of 38 days that had a daily gain or loss greater than 1%, 12 of those days occurring in the month of October. As significant as the daily movements in the equity market have been, their overall results so far have been muted, with the S&P 500 index gaining just under 1% for the quarter. The market’s current volatile nature is a reflection of the macro economic uncertainty that is building. Whether it is the decline in oil & commodity prices, the strengthening US dollar, or when the Federal Reserve is going to raise interest rates, market participants are anxiously parsing out and reacting to each bit of economic news.
Nearly seven years ago, the Federal Reserve embarked upon unprecedented measures to save the economy from falling into a systemic economic depression. Short-term interest rates were reduced to essentially zero, while the Federal Reserve levered up its balance sheet by purchasing more than $3.7 trillion of Treasury and mortgage-backed securities.
The low interest rate environment was initially intended to keep liquidity flowing, but was also seen as a catalyst to spur future economic growth. Unfortunately, the US economy has only been able to achieve a 1.1% compounded annual growth rate over the past 7 years, a stark contrast to the 3-4% growth The Federal Reserve had anticipated. The silver lining is that in the past three years, the economy has grown on average by 2.35%. The low interest rate environment, however, did succeed in catapulting the S&P 500 to all time highs. Now, the overall concern is that raising interest rates will not only snuff out this historic bull market but will act as a headwind to the moderately growing economy. There is a school of thought that believes the hike in interest rates could actually encourage growth by freeing up savings and that could help offset the expected decline from rising interest rates.
I am not an economic soothsayer; I do not have a financial crystal ball or read the entrails of goats. In fact, all of my historic economic forecasting has been notorious for being too early, too late and just plain wrong. That is why Hazelton Capital Partners does not rely on economic predictions as part of its investing process. But that has not stopped the Fund from investing in economically sensitive industries like oil refining or gold mining. Our thesis for investing in these cyclical industries is uniform to our general investing mantra: Invest in companies operating in a niche segment of an industry that can maintain an economic competitive edge. Hazelton Capital Partners does recognize that a rising interest environment and a strengthening US dollar will negatively impact the business models for a number of companies, which is why the Fund has been proactively sidestepping these types of companies.
Hazelton Capital Partners – Top Five Holding: Tesco Plc
Tesco Plc is the third largest global retailer, behind Wal-Mart and Carrefour, and the largest in the United Kingdom. The nearly 100 year old company focuses primarily on the grocery and general merchandise market and commands a 30% market share in the UK grocery market. The company has retail operations in 12 countries in Europe and Asia, and since the 1990’s, has expanded its retailing to include books, electronics, clothing, furniture and financial services.
Starting in early 2014, Tesco began to run into some significant operational challenges, most, if not all, were of its own design. The company’s sheer size and recent focus on international growth (outside the UK) caused its management to become distracted and slow to react to changes in consumer spending habits. Discount retailers, like Aldi and Lidi, took advantage of Tesco’s slow response and began to encroach on its market share. By September, a new CEO, David Lewis, was brought in from Unilever to right the ship.
He began shrinking the company’s retail footprint by closing unprofitable stores and cancelling recent expansion plans. The cash raised from the sales and cost savings were to be used to reduce the debt on the balance sheet. But before Lewis could settle into the new job, he was forced to deal with accounting irregularities that had overstated profits by £250 million. Investors, already disappointed with Tesco’s declining market share, began to lose faith in the UK retailer, and by December 2014, its share price had declined over 50% from the beginning of the year.
In late November through early December, Hazelton Capital Partners built its position in Tesco. There is no doubt that the company’s new management faces significant challenges to return the company to profitability and growth. But it appears that management is taking the proper steps by first shrinking its retail footprint to match the current landscape and using cost savings to de-lever its balance sheet. One of the benefits of investing in a 100 year-old company like Tesco is that the sum of its parts is often priced higher than where the company currently trades. Tesco has an extensive land holding that has been depreciated over a number of years. On its balance sheet, Tesco values its property, plant and equipment (PP&E) at £24 billion but believes the market value to be well over £34 billion. Adjusting for the higher PP&E, the new book value of the company is over 35% higher than the company’s current market capitalization. Additionally, management’s decision to eliminate non-profitable stores will help resuscitate operating margins. With current margins less than half of what they used to be a few years ago, even a small positive momentum will go a long way in improving Tesco’s value and its share price.
Hazelton Capital Partners – Current Holding: Comstock Mining
In November of 2014, I presented Comstock Mining, a gold miner, at an investment conference. The title of the presentation was: “When is a gold miner a value investment?” Recently, Hazelton Capital Partners has been building its position in LODE, and even though Comstock is not currently one of the Fund’s top five holdings, I wanted to share my reason for