The exposures at Newbrook Capital have changed significantly over the year. In August of 2015 the long / short hedge fund had 41% net exposure. Fast forward one year later and Robert Boucai’s fund has only 23% net exposure – and this came after they “modestly increased gross and net exposure as volatility and uncertainty subsided as the Federal Reserve backed off interest rate increases and global markets displayed increased certainty about central bank policy.”
The hedge fund was up 2.7% net in the second quarter, according to an investment letter reviewed by ValueWalk. Longs added 3.1% but shorts subtracted -0.4% from gross performance.
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Newbrook concerned but generally positive: Brexit, China and “election uncertainty” weighed on outlook
Despite a more dovish global central bank policy, Newbrook is slightly more concerned about the macroeconomic outlook, particularly “notable risks” following Brexit, a slowing economy in China and what they viewed in the July investment letter as uncertainty in the U.S. election.
With nearly 24% of the Fund’s gross exposure was invested outside of the US, the extent of the economic recovery – in its eighth year – is a slight concern. Historically the extent of economic recovery has lasted seven years, but Newbrook, pointing to a return to fundamental investment concepts, remains generally positive.
“The US is entering its eighth year of its economic recovery and a recession in the next few years is possible,” the letter said, pointing to growth going forward being “modest” and potentially in line with the Atlanta Fed projections of second quarter 2.3% GDP growth, up by 0.8% over the first quarter.
“We do not believe a recession is likely this year as there are no obvious areas of excess such as those seen with housing and consumer debt in 2007, the TMT bubble in 2000, or the commercial real estate / S&L crisis in 1989,” the letter said
For long exposure, Newbrook considers themes of Internet proliferation, free cash flow and cable consolidation
The Newbrook long / short ratio being relatively tight is a portfolio management tactic that is driven in part by investment themes.
On the long side, their generally modest 64% exposure is mostly centered around secular and defensive themes “and should be more insulated from an economic slowdown.”
Portfolio managers believe in the concept of Internet proliferation, with their top three sector investments being Tencent, Facebook, and Amazon. They also like free cash flow transformations, preferring companies paying dividends and returning cash to shareholders. The top three picks in this theme are Spectrum Brands, Constellation Brands, and Berry Plastics. The final long theme is cable consolidation, where they pointed to portfolio exposure to Charter Communications and Altice, “both of which have benefitted from consolidation and recent acquisitions.”
Themes driving the short book are based on entirely different criteria. Newbrook looks for stocks exposed to changing business cycles, which can be seen to various degrees in aerospace, autos, iron ore, and quick service restaurants. They also consider market share losers, particularly where increased supermarket competition comes into play. “Our short book remains aggressively positioned as we look to uncover new opportunities.”
Newbrook short Goodyear
One of the new short opportunities is Goodyear Tire and Rubber Company, which they note is operating at the highest level of profitability in the company’s history. In a case of selling at an extreme positive level, Newbrook thinks the trend is about to end:
While a confluence of positive factors has created an ideal environment for Goodyear and the industry, we believe evolving dynamics will reverse many of these trends. The company has benefitted from massive raw material tailwinds, relatively strong end-market demand, tight supply, and an unusually disciplined pricing environment, but many of those factors are changing .
The hedge fund notes further:
Downside to Earnings Estimates Consensus sell-side estimates project Goodyear s operating margins increasing by an incremental 1.3% this year and generally holding steady from those new record levels going forward. We believe the combination of increasing industry capacity, higher raw material costs, and the commoditization of the HVA segment will result in margins trending closer to the long-term average level in the single digits. We therefore believe consensus EPS estimates of over $4.00 in 2017, 2018 and beyond are overly optimistic, potentially by a factor of 2x. As margins and earnings normalize, the market should recognize this business for what it is: a highly capital intensive, low return business
One of the primary reasons industry pricing has been so disciplined is that supply / demand has been relatively tight after capacity was significantly reduced during the downturn. Now that demand has recovered over the last several years, the industry has returned to adding capacity. In the North American market, 2015 was the first year that any net material supply was added with a 1.7% capacity increase. This is accelerating in 2016 and beyond with 3.1% supply additions this year and 2.8% next year. This is even more dramatic on a global basis with close to 4% capacity additions this year. The increased supply in the industry will put downward pressure on pricing as manufacturers need to run the new plants at close to full utilization. While tariffs have largely pushed Chinese imports out of the U.S. market, this volume was quickly filled by other low cost tires, primarily from other Southeast Asia countries. The 50 million units of Chinese imports will need to find a home in other countries, which could depress prices in other regions. According to the China Petroleum and Chemical Industry Foundation, the more than 300 tire manufacturers in China operate at 70% of capacity, far below the 85% that economists say is needed to generate profits. Chinese tire exports increased tenfold between 2000 and 2013, and the Asian region in total has been adding 30 to 35 million units of new capacity per year (more than 2% of global demand).
Newbrook thinks Goodyear’s benefiting from lower raw material costs – rubber and oil – is likely to end and that overall industry supply will increase and extra production capacity is tapped in plants. With only a 13% market share, Goodyear is far from having “pricing power” and in fact risks operating in a commodity industry. Newbrook thinks Goodyear’s benefiting from lower raw material costs – rubber and oil – is likely to end and that overall industry supply will increase and extra production capacity is tapped in plants. With only a 13% market share, Goodyear is far from having “pricing power” and in fact risks operating in a commodity industry.
Newbrook Capital concludes:
Downside to Earnings Estimates Consensus sell-side estimates project Goodyear s operating margins increasing by an incremental 1.3% this year and generally holding steady from those new record levels going forward. We believe the combination of increasing industry capacity, higher raw material costs, and the commoditization of the HVA segment will result in margins trending closer to the long-term average level in the single digits. We therefore believe consensus EPS estimates of over $4.00 in 2017, 2018 and beyond are overly optimistic, potentially by a factor of 2x. As margins and earnings normalize, the market should recognize this business for what it is: a highly capital intensive, low return business
On the other hand, Mick McGuire’s Marcato Capital Management is bullish on the stock stating in a recent letter to investors:
Goodyear Tire is an iconic tire brand that is benefiting from structural improvements to profitability and several operating tailwinds. Goodyear makes almost all of its profits from the sales of replacement tires. New car sales matter in that they represent a ~4-yr leading indicator of incremental replacement volumes as cars approach their first tire replacement, but new cars are still a small percentage of the overall auto population where tire replacements are influenced by miles driven (primarily a function of employment and gas prices). All of these nconditions point to a favorable backdrop for Goodyear.
Our analysis shows that raw materials are quickly passed through to the retail price and offer neither a headwind nor tailwind over time and that supply growth has been consistently overestimated as they fail to account for plant closures and volume reductions that occur when converting from production of commodity tires to highly engineered tires. Goodyear is on track to deliver its third consecutive year of double-digit growth in operating income. With an $8.4 billion market capitalization and $13.6 billion Enterprise Value, GT trades at 5.2x EBITDA and an 11% FCF yield on our 2016 estimates and recently announced a new $650m share repurchase program.
Newbrook thinks Goodyear’s benefiting from lower raw material costs – rubber and oil – is likely to end and that overall industry supply will increase and extra production capacity is tapped in plants. With only a 13% market share, Goodyear is far from having “pricing power” and in fact risks operating in a commodity industry.
Newbrook long Dave and Buster’s
On the long side of the equation, the fund likes Dave & Buster’s Entertainment, which despite having a highly successful roll out and demonstrating strong unit economics, still remains uncovered by the bulge bracket banks.
“After two rounds of private equity ownership, Dave & Buster’s was taken public by Oak Hill in October 2014,” the letter opined. “Despite stellar stock performance (IPO priced at $16 and currently trading at $48) only six analysts cover the stock with no coverage from bulge bracket firms.”
This could change, however, as the restaurant gaming concept company continues to expand sales and reduce expenses. Management has projected EBITDA margins can grow above 30% over the next several years. This is bolstered by the company’s same-store sales growth, which outpaced the casual dining segment in each of the last 14 quarters. They didn’t just beat, but did so with average outperformance since the beginning of 2012 of 5.2%.
Photo by andrewblack
