GreenWood Investors letter for the fourth quarter ended December 31, 2015.
Dear GreenWood Investor:
In the last year, GreenWood Investors' concentrated global portfolio has been able to return satisfactory gains, as adept managers were guiding these businesses through transformational moments in their history. The trend we described twelve months ago, of a handful of richly-valued stocks leading the market, has continued, and we believe will likely continue in a very uncertain world. Although we were actively reducing stakes in cyclical and less liquid securities in the later part of the quarter, we have given some of this outperformance back in the beginning of January. We still remain firmly convinced that our portfolio will handily outperform a bifurcated market in which the “haves,” reflect uninterrupted prosperity for decades and the “have nots,” have quickly reflected a significant global recession. We’ve been sorting through the graveyard of broken dreams in the most recent month, and find many of these industrial or commodityrelated companies pricing-in a dramatic recession. On the other hand, technology, much of healthcare and some consumer goods companies are reflecting a continued growing environment. Investors in only one of these segments will be correct, surely not both.
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Exhibit 1: GreenWood Traditional Composite Performance1 vs. MSCI ACWI All Cap (Net)
GreenWood Investors: Performance Contributors And Detractors
Our 2015 performance was broad-based, with Fiat-Chrysler and Finmeccanica leading the way. The main detractor to performance was being too early on an investment in Rolls Royce, which looks set to clear up analyst confusion throughout 2016 as it delivers on its growth and restructuring initiatives. It is notable that the stock has been the best performing investment so far in 2016, as shares already reflected a recession in the aerospace industry with the combined effect of an event similar to the 9/11 attacks plus the 2008 recession in business aircraft utilization. Rolls is not the only stock in our portfolio that already prices-in a substantial recession. Fiat-Chrysler, our only exposure to the U.S. economic cycle, is currently reflecting U.S. unemployment north of 12% and consumer confidence of 50, which would both be unprecedented levels outside of the Great Depression. The surest way to protect against worse-than-expected economic scenarios is to both short euphorically-priced securities, which is dangerous given the unlimited upside such securities offer, or buy assets priced for severe recessions. When we first established our position in Fiat, markets feared Italy’s departure from the E.U. and a collapse of the Italian economy. Shares were priced accordingly, and backing out the value of Ferrari, we owned Fiat-Chrysler for free. Of course, Italy has remained in the eurozone, and the economy’s recovery is accelerating, thus shares have outperformed both the Italian and global markets.
Accordingly, we think despite any gloomy economic headlines in the U.S., FCA will once again perform quite well as the worst-case scenarios are taken off the table.
Our thinking going into the year was that a reduced exposure to the economic cycle would serve us well, but now that the market has hurriedly priced cyclical companies for an imminent deep recession, we have gotten more constructive on many of these investments. Either we are going into a Great Depression, or we are not. If we’re not, FCA should do quite well as it continues executing its margin-expanding plan of product introductions and incentives reductions, all as the Italian economy recovers considerably. The market has thus far punished the Italian stock index more than all others except China in 2016, which is ironic because the country is just beginning to recover from a nine-year economic recession, and consumer confidence has hit a record high in January. The average age of scooters and automobiles in Italy are also at record-highs, and Fiat-Chrysler is delivering outstanding performance as it embarks on a product offensive that it has withheld during a weak economy in order to maximize the company’s return on invested capital. We cannot say the same of nearly any other automaker or country we look at today.
Analysts that cover the company have upgraded all of their estimates for profitability and revenue (but still, not enough), while also downgrading their estimation of what investors will pay for the company in the future. Earnings this year will double, even if U.S. sales decline (which again, we don’t think will happen), and thus a current industry-low Price-Earnings ratio of just over 5x will soon become 2.5x in the next couple of quarters, and under 1.5x next year. By the end of 2016, FCA will sport a net cash position, and if shares remain at current levels, we believe the company will implement an aggressive share repurchase plan - barring a catastrophic financial crisis. At current valuation levels, it would be able to take itself private, with Exor the only remaining holder. Sergio Marchionne has been the only rational capital allocator in an industry of bean-counters and salesmen, and will not waste an opportunity to improve his career outperformance over the stock market from ~30x to perhaps 40x or 50x.
Exhibit 2: GreenWood Model Portfolio Composition as of 12/31/15
The cheap sometimes get cheaper, which is both the curse and the advantage to being a contrarian value investor. For level-headed investors that are willing see an unwarranted selloff for exactly what it is, it’s a fantastic buying opportunity. Should the fundamentals of the business deteriorate further than what the market predicts, then the buying opportunity becomes a value trap. Accordingly, it’s important to look for undue pessimism and a deeply discounted valuation, which both become the investor’s margin of safety as long as he is able to stay invested longer the irrationality persists. Fiat-Chrysler, Rolls Royce, Exor, and Ferrari already reflect a worsening of conditions far greater than what we saw in 2009. Finmeccanica's fair value is steadily rising and is currently double where it trades. The company, along with Rolls and other European defense contractors, will play a crucial role in helping restore Europe's ability to combat ISIS.
Early in January, we participated in the Manual of Ideas’ Best Ideas Value Conference (link available in The Grove), and we talked about the fact that most institutional investors today cannot focus beyond a six month time horizon. Because we’ve taken deliberate steps to being completely transparent with our investments and strategy, we’ve had the good fortune to attract like-minded investors. In fact, the organization Five Star Professional recently recognized us in an advertisement in the New York Magazine, as our investor satisfaction is in the 99.8 percentile in the New York region, which we believe is the most competitive region in the world.
As a result, we’ve been able to put our money where our mouth is, and take full advantage of chaotic market environments. Our average holding period has always averaged out around three years, which is five times the current typical investor. This has enabled us to have an edge over the vast majority of market participants who “window-dress,” at the end of a quarter or month in order to make it appear to investors that they are following their specific mandate. These investors are simply not able to hold assets when the next couple of weeks or months won’t assuredly deliver great news, as if anything is a sure thing in the world.
The other facet of investing we’ve been very focused on is further defining our specific specialty. The best generalist investors have all had particular areas that they’ve excelled in, and have rarely strayed from these opportunities. Rare are the investors that are able to identify a Facebook in an early venture capital round, but also invest in distressed situations. In fact, such an investor probably doesn’t exist. If we look at our most successful investments, they have been made when we’ve taken a view on the company beyond the next six months and where confusion and emotions were running high among the investor base. Our typical diligence process has been more rigorous than that of most private-equity investors, and we’ve used this process to help give us conviction in the valuations at which we’re able to buy these businesses, often times with short-term underperformance. Of the best investments, the quality of the management teams and the long-term durability and attractiveness of the businesses have been the most reliable predictors of success.
That bodes well for our year ahead, both through our current positions and through the opportunities that have opened up in the most recent month. While all major investments have value-creating events in the near future, the average market participant is unaware of all these near-term opportunities. Confusion is running high around nearly all of their fundamentals. That’s the way we’d prefer to enter a year, with the odds stacked in our favor and a market ignorant to the potential. We’ll use the setback of January to add to this opportunity set. When the macroeconomic picture looks foggy, we already know what to do. We've done it before. When the market doubts what we know to be true on a micro-level, we always hunker down, add to the positions in which we have conviction, and outperform in the long-run. When everyone has lost their heads, keeping ours firmly intact has always benefited us. Thank you for the gift of your trust, it has enabled us to face this environment with conviction and enthusiasm.
Steven Wood, CFA