Bretton Fund annual letter to shareholders for the year ended December 31, 2015.
Dear Fellow Shareholders:
The Bretton Fund’s net asset value per share (NAV) as of December 31, 2015, was $23.98. For the year, the fund returned -6.59% compared to the S&P 500’s 1.38%.
David Einhorn’s Greenlight had a strong fourth quarter; Gains on Neubase Therapeutics [Full Q4 Letter]
David Einhorn's Greenlight Capital was up 5.2% in 2020, underperforming the S&P 500's 18.4% return. For the fourth quarter, the fund was up 25%, which was its best quarterly result ever. Longs contributed 42% during the fourth quarter, while shorts detracted 15% and macro detracted 1%. Q4 2020 hedge fund letters, conferences and more Growth Read More
Bretton Fund – 4th Quarter
For the fourth quarter, the total return for the Bretton Fund was 1.84% compared to 7.04% for the S&P 500 Index. The largest impact on the fund’s performance was Alphabet, Inc., the parent company of Google, which increased the fund’s value by 1.1%. Ross Stores added 0.6% to performance, while paint company Valspar chipped in 0.6% and Wells Fargo added 0.5%. The biggest detractors from performance were Community Health Systems, taking away 1.0% from performance, and Union Pacific, which took away 0.5%.
The Bretton Fund closed out four positions during the quarter: IPC Healthcare, CSX, The Gap, and New Resource Bank. IPC, our hospitalist-staffing company, was acquired by a larger competitor, Team Health; our total gain was 91%. We sold CSX to reallocate our rail investment toward Union Pacific, the more promising investment. Our annualized return (aka, internal rate of return or IRR) was 7.3%. The Gap (33.4% IRR), originally purchased in 2011 at distressed values because of a temporary spike in cotton prices, has long since recovered, but its recent fashion struggles gave us less confidence in its long-term earning potential. New Resource Bank (12.0% IRR), which we have owned since early 2011 as it was recovering from the financial crisis, has since rebounded nicely.
We initiated a position in data analytics company Verisk during the quarter.
Bretton Fund – Contributors to Performance for 2015
The largest negative contributor to performance during the year was our rail investment, which reduced the Bretton Fund’s value by 3.6%. Over time, US rail traffic does a remarkably consistent job of tracking slightly ahead of the industrial economy, but traffic can be lumpy from year to year. Rail volume in 2015 declined only 2.5%, including a pronounced deterioration toward the end of the year, dropping 9% in December. Despite a slowly recovering economy overall, US industrial production has been weakening, particularly in energy-related industries. We are now six or seven years into widespread hydraulic fracturing, which has slashed prices for natural gas and made coal uneconomic in many places for power generation. For most of this time, the railroads have been able to replace declining coal volume with increased traffic in other goods; in 2015, far more coal fell out of the system than the rails were able to replace. We think the railroads’ superior economics remain intact: faster delivery times and lower prices are still allowing them to take share from trucking, improving technology is still reducing their operating costs, and limited competition allows for strong pricing. Rail traffic is cyclical, and the market tends to overreact to upswings and downswings. Over the long run, we are confident our remaining rail investment, Union Pacific, will continue to increase its earnings.
The other investments that materially hurt the year’s performance were Community Health System for a -2.1% impact, American Express (-1.4%), Flowserve (-1.2%), and Discovery Communications (-1.1%).
The largest positive impact to the Bretton Fund’s performance in 2015 was the acquired IPC Healthcare, which added 2.0%. Other contributors were Alphabet (1.2%) and Ross Stores (1.0%).
Bretton Fund – Taxes
The Bretton Fund made a long-term capital-gain distribution of $0.04498 per share to shareholders on December 23, 2015, amounting to 0.19% of the fund’s NAV. It was the fund’s first capital gain distribution in three years. There were no other tax distributions this year.
Bretton Fund – Portfolio Discussion
Retail & Consumer
It’s starting to sound like a broken record, but Ross continued to build stores, increase its sales per store, and return money to shareholders. We estimate its earnings per share increased 13% (Ross hasn’t announced its results yet), and its stock’s total return was 15.2% in 2015.
People keep buying baby clothes. We estimate Carter’s increased its earnings per share by 14%, while its stock returned 3.0%. The stock was fairly volatile during the year, and we added more at the lower prices.
Like Ross, AutoZone opened more stores, increased its per store sales, and bought back a lot of stock, translating a revenue increase of 8% into an earnings per share increase of 14%. Our return over our average cost was 6.4%.
Armanino’s growth was hurt a bit as its sales of pasta sauce in Asia translated into fewer US dollars given the stronger dollar. Earnings per share increased 5%, and its stock returned 0.7%.
Whole Foods Market expanded its store base last year, building 38 stores and growing its square footage by 10%, but had a hard time with per store profitability. After decades of virtually unimpeded growth, competition is starting to have a real impact on Whole Foods. Sales per store grew 2.5% for the full year, but declined in the fourth quarter. Whole Foods has had to lower prices to match the competition, and its gross margin dropped from 35.5% to 35.2%. Earnings per share declined 5%, and our unrealized loss on the stock is 15%. The increased competition is troubling, and we’re watching it, but we still think Whole Foods can build a lot more stores, potentially up to three times what it has today.
The good news for our banks—Wells Fargo, Bank of America, and JPMorgan Chase-was that their earnings continued to grow and they continued to return capital to shareholders. The bad news was that the Federal Reserve didn’t increase interest rates until the end of the year, which kept a damper on revenue growth.
While a bit obscured by ultra-low rates, Wells Fargo continued to do what it does: add customers, loans, and deposits. Compared to other developed countries, banking in the US is highly fragmented, and Wells Fargo has plenty of runway to grow. Wells Fargo grew its earnings per share by 1% last year, and its stock returned 1.9%.
Given their larger problems during the financial crisis, JPMorgan and Bank of America had more to improve upon compared to Wells Fargo, and they continued to do so. JPMorgan increased its earnings per share by 13%, and its total return was 8.2%. Bank of America’s earnings per share nearly quadrupled—off a low base—and the stock’s return was -4.8%.
Media & Technology
Despite the stock increasing 42% in 2015, we still find Alphabet (better known by the name of its largest subsidiary, Google) a bargain compared to how rapidly its earnings are growing. Earnings per share are on track to increase 25%, and we’ve seen a 15.6% gain over our average cost. On a global basis, Alphabet has a strong competitive position (how often do you “Bing” something?) and a suite of critical customer touch points that address basic user questions: search to help people find information, email and messaging to communicate the information, phone and mapping to make the information accessible and geographically relevant. What tipped us into the stock last year was management indicating they’d be more cost-conscious and shareholder-friendly than they had in the past.
Like all US businesses with meaningful foreign operations, Discovery Communications (Discovery Channel, TLC, Animal Planet, and others) faced tough headwinds this year from the decline in global currencies versus the dollar. Adjusting for the currency, management estimates earnings per share increased by a low double-digit percentage. Its US business grew nicely with surprisingly strong ratings for its revamped lineup; its international business grew even faster. But the stock struggled, dropping 22.6%, as investors became concerned that “cord-cutting” could unwind the pay-TV ecosystem. We do think cord-cutting will continue to happen, but at a modest pace, while Discovery’s international business will continue to grow quickly and more than make up the difference.
Verisk was our lone purchase in the fourth quarter. Verisk was founded in 1971 by large property insurance companies so they could pool together their actuarial data and help them make better decisions about rates and probabilities. About 15 years ago, management convinced their insurance company owners to let them convert Verisk into an independent, for-profit company. Since, Verisk has identified and acquired other companies serving as central repositories for granular, difficult-to-replicate data sets. It purchased similar data sets in other countries, then acquired health insurance information, environmental health and safety information, and, with last year’s purchase of Wood Mackenzie, natural resources information. In each case, the data is costprohibitive for one user, yet it costs a negligible amount to add an incremental user, so the product can be deployed attractively across an entire industry. Our return so far is 7.4%.
T-Mobile has been treading water for the past six months. The “uncarrier” positions itself as the high-growth alternative to wireless market giants Verizon and AT&T. The company has performed well operationally, but most of the excitement centers around the strategic value of merging the company with another market participant. We believe that the government is hesitant to allow for further consolidation among the majors in the wireless market, which would, in our view, possibly allow for consolidation with a new entrant, such as spectrum-rich DISH or Comcast. This, in turn, might create an alternative network using its large base of customer routers. Our return over our average cost is -1.4%.
Housing & Building Products
HD Supply’s business of selling building-maintenance products and construction materials improved as the building market recovered. Revenue grew around 6%, and earnings grew even faster, almost doubling, as those additional revenues were spread over a similar fixed-cost base. The stock is down 9.9% from our average cost.
We purchased Valspar, the paint and coatings company, on the heels of a large reduction from its largest customer, Lowe’s Home Improvement. The Lowe’s business was low margin, and the rest of its business, including its food container business, thrived. Earnings per share increased 6%, and our return over our average cost is 1.2%.
PGT, our Florida-based maker of impact-resistant windows for hurricanes, saw a big jump in its earnings from a number of factors: improvement in the Florida housing market, acquisition of its largest competitor, and the achievement of economies of scale with a new factory. We expect earnings per share increased over 30% from 2014. The stock’s return was 9.1%.
Industrial Products & Transportation
It may not feel like it, but after a sharp and painful financial crisis in 2008–2009 the US economy has made a pretty good, albeit slow, recovery. Indeed, the current economic expansion is one of the longest in US history. Unemployment levels are low, consumer spending is increasing, home prices are increasing, and consumer debt levels are low. But this past year has been a poor one for the industrial economy, and it’s likely to get worse. Low oil and commodity prices, in part caused by a severe, long-coming slowdown in China, combined with a weak European economy, have put the brakes on the demand for high-ticket machinery. The US economy is one of the sole bright spots in a weak global economy; that, along with the world anticipating higher US interest rates, caused the dollar to strengthen considerably. Businesses with significant foreign operations made much less in dollar terms.
We started the year with three rail investments, and when the price of Union Pacific dropped sharply, we focused our rail allocation on Union Pacific. Given its territory includes long hauls in the western US, access to the Pacific Ocean, and connections to Mexico, it has a stronger advantage over trucking and will benefit from increased trade with Asia and Mexico. It also has a much smaller proportion of coal traffic than the eastern railroads, and its coal traffic originates in the Powder River Basin, the lowest-cost coal region in North America. Earnings per share declined 5% last year, and the stock’s return was -32.5%. With the shares down so low, we think the market is giving us a great business at a distressed price.
Pump manufacturer Flowserve saw its earnings per share drop by almost 20%, much of that from the stronger dollar, and its stock’s return was -28.5%. Flowserve does a lot of its business in energy and emerging markets, both tough places to be last year. Despite the harsh environment, most of its revenue is driven by recurring maintenance on the installed fleet of pumps, not one-time sales. Its oil and gas business is mostly in refineries—not drilling—which operated at record volumes and uptime levels in 2015. Refinery owners are loathe to pause production when the market is hot, but we think the current practice of deferring maintenance will reach its natural end. Adjusted for the effects of currency, management estimates earnings per share only dropped 5–7% last year.
Nordson, the maker of adhesive-application equipment (the machines that apply glue to consumer products like diapers and juice boxes), similarly saw its international business hurt by the currency decline. Seventy percent of its revenue is from outside the US, so its 7% increase in earnings per share before the effects of currency translated into a 10% decline in dollar terms. Our return on the investment so far is -18.1%.
MEDNAX, our doctor group of neonatologists and anesthesiologists, kept up its rapid growth, increasing earnings per share by 13% by acquiring doctor groups around the country. We think they have a very long runway to maintain this pace, and we think we’re getting this business at a wonderful price. Our return over our average cost is -4.5%.
Community Health Systems went through a perfect storm of bad news in the fall; our return so far is -46.1%. Hospital economics are highly dependent on the breadth of insurance coverage; hospitals are forced to provide many kinds of care to all who arrive, yet patients without insurance coverage are rarely able to pay. The Affordable Care Act (ACA) was meant to remedy this, but throughout the fall there were alarming stories that enrollment might have peaked. Furthermore, the announcement by UnitedHealthcare, the largest insurance company in the US, that it is likely to cease offering ACA policies highlighted the concern of a “death spiral,” in which rates rise and healthy people drop out of the insurance pool, causing rates to rise again. As this drama played out, credit markets deteriorated and it became unlikely Community could raise the financing to complete a planned spinoff of its rural hospitals. We own the company for less than 10 times earnings.
Centene is the leading provider of Medicaid Managed Care (MMC) in the country. Although the ACA is best known for its online exchanges for individual insurance policies, more people are covered through the expansion of Medicaid, and these programs are increasingly insured by private firms that contract with states at a capitated rate. While large commercial insurers compete on the basis of network breadth, the MMC providers compete on the basis of network cost: the ability to recruit a provider population willing to work for Medicaid’s low rates. When the dust settles from the flurry of health insurance mergers, Centene should be the fourth largest private health insurance company, and one of the very few of any size that can deliver high service quality scores to lower-income Americans at sustainable economics. These economics should improve materially with the pending Health Net acquisition, which will generate savings by eliminating duplicative overhead. So far, our return is 7.7% over our average cost.
American Express’s stock price was hit hard when it lost its contract as the exclusive credit card to Costco. The total return on the stock in 2015 was -24.1%. In addition to losing Costco, American Express was hurt by the strong dollar, as well as weak pricing, as it lowered its rates to some vendors to encourage smaller merchants to take AmEx. Earnings per share declined 9%. American Express is certainly facing some real challenges: weak currency, tougher competition for co-branded cards, and an anemic spending environment. But it also has a lot going for it: its market share in the US card market is 25%, up from 20% 15 years ago; it has a disproportionate share of large spenders, online purchases, and mobile purchases; the world is steadily shifting from cash/check to cards; and, importantly, we believe the stock is very cheap.
Our other payments investment, MasterCard, had a much easier go of it. Despite tough currency headwinds (70% of its business is outside the US), it was able to increase its earnings per share by 11% (18% without any currency impact). Like American Express, MasterCard is benefitting from the steady conversion of payment to card from cash; MasterCard, along with its chief competitor Visa, is growing considerably faster because more of its business is in developing markets where that conversion trend is more pronounced. Our return so far on its stock is 8.2%.
As always, thank you for investing.
Raphael de Balmann