Value-focused fund URI Capital Management produced a return of 22.85% net of all fees and expenses for investors for the full-year 2017. Since inception (August 2012), the firm has produced an annualized return of 17.07% for investors according to a copy of its year-end 2017 letter that has been reviewed by ValueWalk.
Gator Capital On Alpha In Financials
Brian Pitkin, Founder and Managing Partner of URI Capital, is a value investor at heart, who’s not afraid to take significant positions and hold stocks for the long-term. During the year, the firm only initiated one new position, a holding in UK-based bank Barclays that was first established in 1690.
Financials feature heavily in URI's portfolio. The top four holdings dominate 80% of assets. Each of these positions trades under 1.2x book and 12.5x earnings.
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URI Capital: Alpha In Financials
In a world that's dominated by technological change, the financial sector is "timeless and innovative" Pitkin writes in his full-year letter to investors. Banking is an "enduring business" that's been around for 1000s of years, and it has always managed to adapt and change with the times. Today's institutions have been able to bring "scale to innovation" through large research budgets. The letter points out, "JP Morgan spends roughly $9 billion a year on technology." The bank is also investing heavily in the blockchain, which could bring "tremendous transactional efficiencies to the consumer and corporate sides of the business."
Barclays is another prime example of bankings' ability to endure. Started in 1690, the business has 325 years of history behind it. Today, the bank is struggling to turn itself around thanks to an expansion into investment banking, which has not proved to be as lucrative as management initially expected. A restructuring has hit the group's images as costs have mounted, and the bank has reported losses. Now, these efforts are starting to pay off. "The core businesses have posted strong underlying results while many non-core aspects of the business have been sold or run down," Pitkin writes in his letter. While Barclays isn't in the clear just yet, "much has already been accomplished," and the firm's outlook is improving every day.
At the end of Q2 2017, Barclays' tangible book value per ADR share was $15.22 looking forward two years, URI is estimating "book value per ADR of $20.63 with tangible book value approaching $17.75." 10% returns on this measure on tangible equity could produce earnings per ADR around $1.78. Placing a multiple of 12x on this "would yield value of $21.36, corresponding roughly to where we expect full book value in a couple years."
As well as Barclays, URI also owns JP Morgan, Bank of America and AIG, all of which Pitkin believes are undervalued compared to their long-term earnings potential.
Specifically on AIG warrants, URI Capital opines:
As for return potential, it would not be out of line with historic norms for AIG to post 12% ROEs and corresponding valuations in the 1.5x book value range where its better regarded competitors trade TODAY. (Also of note, over the 20 years before the crisis from 1988 to 2007, AIG’s average price to book value was 2.5x.) At a 1.5x book valuation corresponding with warrant maturity in early 2021, the stock price would double and the warrant value would increase by a factor of four. We would see a stock price at or above $120 (compared to the low $60s today) which would correspond to value in warrants above $82 (compared to the low $20s today). While it is of utmost importance that the investment can bring good returns in downside scenarios, you can clearly see how historically reasonable scenarios can lead to outsized returns.
To consider this future valuation from an earnings perspective consider that 12% returns on our more conservative measure of book value would drive earnings per share above $10 in 2021. Applying a historically reasonable 12x multiple to those 2021 earnings would bring us back to that same $120 per share value at warrant maturity. Measures of returns around 12% and value surrounding 1.5x book or 12x earnings are more than historically reasonable and have been well exceeded in the past.
