Hazelton Capital Partners letter to investors for the second quarter ended June 30, 2015.
Hazelton Capital Partners, LLC (the “Fund”) declined 7.5% from April 1, 2015 through June 30, 2015, declined 7.75% year-to-date, and has returned 79% since its inception in August 2009. By comparison, the S&P 500 gained 0.3% in the same quarter, increased 1.2% year-to-date and has returned 127.5% since the Fund’s inception.
Hazelton Capital Partners Performance – The Quarter in Review
Hazelton Capital Partners ended the 2nd quarter with a portfolio of 18 equity positions and a cash level equivalent to 15% of assets under management. The Fund’s top five portfolio holdings, which are equal to 36% of the Fund’s net assets, are: Western Digital, DreamWorks Animation, Apple, Renewable Energy Group and Cisco Systems. Throughout the first five months of the year, Hazelton Capital Partners vacillated between slightly up to slightly down on the year. In June, there was a downturn in the portfolio, lead by a decline in a number of our holdings, including Western Digital, which accounted for half of our YTD decline.
Hazelton Capital Partners - Risk vs. Volatility
In the financial media, "risk" and "volatility" are often used interchangeably to describe the movement of a company's stock price. A company with a volatile stock price is often considered to be a risky investment, unless the price of the stock steadily increases, and then it is considered a growth stock. Hazelton Capital Partners defines risk as the exposure to danger, harm or loss, while volatility is simply a mathematical equation that measures the change of an asset's price over a period of time. Risk and volatility have nothing in common. The key ingredient behind volatility is uncertainty; it harnesses the emotional power of fear and greed, leading to a myopic and short-term reaction (overreaction). The greater and longer the uncertainty persists, the more a stock price will vacillate. In most cases, these knee-jerk responses to buy or sell shares completely ignores the fundamental and future intrinsic value of a company.
Instead of fighting it out in the scrum, Hazelton Capital Partners chooses to stand outside the chaos and wait for a stock price to provide a buying or selling opportunity. Hazelton Capital Partners is vigilant with our investments, consistently searching for changes in their long-term intrinsic value and stands ready to remove a company from the portfolio when necessary.
Hazelton Capital Partners - Renewable Energy Group (REGI) Current Holding
Renewable Energy Group, Inc (REGI) is the largest producer of biodiesel in the United States. With its flexible use of feedstock and national logistics and distribution network, REGI has become the low cost US producer of biodiesel. The company has grown its refining capabilities from 12 million gallons in 1996 to its current nameplate level of over 330 million gallons, representing approximately 25% of domestic biodiesel production. Through construction and acquisition, REGI has gained an expertise in retrofitting and optimizing production facilities, sourcing feedstock, marketing, selling and distributing its products. With the recent acquisition LS9, Renewable Energy Group plans to leverage its infrastructure, sourcing, and production facilities and expand into commercial grade specialty chemicals using bio-based feedstock.
The US biodiesel industry is highly fragmented with 75% of the refiners producing only 33% of total production. Of the top biodiesel producers, Renewable Energy Group is the only independent refiner and competes with agricultural processors like Cargil, ADM, Louis Dreyfus Commodities and AGP. Biodiesel's refining process uses a variety of agriculture oils (edible, inedible and used cooking oil), grease and animal fat as feedstock and is functionally identical to petroleum-based diesel fuel. However, pure biodiesel (B100) emits CO2 and hydrocarbon levels that are up to 80% and 60% less than its petroleum counterpart. Reduction in greenhouse gases from biodiesel and other bio-based fuels did not go unnoticed by the EPA (Environmental Protection Agency), and as a result, the agency established the RFS (Renewable Fuel Standard) program. The program requires transportation fuel sold in the United States to contain a minimum amount of bio-based fuels. Each year, the EPA sets its RVO (Renewable Volume Obligations) target for the amount of bio-based fuels to be blended with petroleum fuel. For 2015, 1.7 billion gallons of biodiesel is required to be blended to satisfy the government’s requirements. That number increases by 100 million gallons a year over the next two years, hitting 1.9 billion gallons by 2017, nearly tripling the 650 million gallons required in 2010.
To monitor the amount of biofuels being blended each year, the US government issues Renewable Identification Numbers (RINs) for every gallon of biofuel created. These RINs have a value which are embedded in the price of a gallon of biodiesel and can be used to offset tax liabilities of the company that either produces or blends the biofuel. The cost of a gallon of biodiesel is approximately the same as petroleum diesel once you strip out the cost of RINs and other embedded incentives. Besides the price of oil, biodiesels prices are also influenced by the price of soybean oil (the most common feedstock), RFS production levels, and the spot price for RINs. In addition to the RIN program, the Federal Government also incentivizes production of biodiesel with the Blenders Tax Credit (BTC). Established in 2005, the BTC provides a tax credit of $1.00/gallon to either a producer or blender of B100 biodiesel. In December of 2013, the BTC expired and its fate remained uncertain until it was retroactively reinstated in the last weeks of December 2014. Currently, the US Senate is working on a tax extenders package that would reinstate the $1.00/gallon biodiesel blenders tax credit.
Even though demand for biodiesel continues to grow, refining biodiesel remains a challenging business. The ongoing uncertainty surrounding whether Congress will renew the BTC along with the EPA's nearly 2 year delay in updating their RVO targets (the new targets were just announced May 31, 2015) have lead to volatile biodiesel prices and margin pressure. This uncertainty and price volatility actually create an opportunity for REGI. Being the largest domestic biodiesel refiner, Renewable Energy Group has significant competitive advantages over many of its competitors. With feedstock representing 80-90% of production costs, REGI's multiple refineries, production size and its ability to "fill-in" for higher amounts when needed provides the company with the ability to reduce production costs. Additionally, REGI’s refining plants have been constructed or retrofitted to provide the flexibility to refine a variety of feedstocks; 83% of REGI's feedstock comes from animal fats, white and yellow grease, used cooking oils, and inedible corn oils. Soybean oil is the most common and expensive feedstock and is used by the majority of biodiesel refiners, especially refiners that are also agricultural processors (Cargil, ADM, Louis Dreyfus Commodities and AGP). This flexibility in sourcing provided REGI with a $0.25/gallon advantage over competitors in 2014. As the market continues to consolidate, it is expected that REGI will expand its footprint, acquiring strategic properties at distressed levels.
Renewable Energy Group's recent acquisition of LS9, a R&D company focused on development of renewable chemicals, is expected to create cheaper feedstocks, reducing the production cost of biodiesel. It is estimated that development of alternative feedstock, as well as continued optimization of its refining process, could reduce Renewable Energy Group’s production costs by as much as 35%. LS9