Hazelton Capital Partners’ letter to partners for the first quarter ended March 31, 2015.
To: Hazelton Capital Partners, LLC
From: Barry Pasikov, Managing Member
Date: April 23, 2015
Re: 1st Quarter 2015 Letter to Investors
Hazelton Capital Partners, LLC (the “Fund”) declined 0.25% from January 1, 2015 through March 31, 2015, and has returned 85% since its inception in August 2009. By comparison, the S&P 500 gained 0.95% in the same quarter, and has returned 127% since the Fund’s inception.
Hazelton Capital Partners Performance – The Quarter in Review
Hazelton Capital Partners ended the 1st quarter with a portfolio of 17 equity positions and a cash level equivalent to 17% of assets under management. The Fund’s top five portfolio holdings, which are equal to 37% of the Fund’s net assets, are: Western Digital, DreamWorks Animation, Apple, Tesco (TSCDY), and Northern Tier Energy (NTI).
Hazelton Capital Partners: Much to Do About Nothing – So Far
During the 1st quarter of 2015, there were a total of 20 days (1/3 of the quarter) in which the S&P 500 index had a daily gain or loss that was greater than 1%. In fact, some have since rebranded the Standard & Poor’s 500 as the Schizophrenic & bi-Polar 500. By way of comparison, for all of 2014, there were a total of 38 days that had a daily gain or loss greater than 1%, 12 of those days occurring in the month of October. As significant as the daily movements in the equity market have been, their overall results so far have been muted, with the S&P 500 index gaining just under 1% for the quarter. The market’s current volatile nature is a reflection of the macro economic uncertainty that is building. Whether it is the decline in oil & commodity prices, the strengthening US dollar, or when the Federal Reserve is going to raise interest rates, market participants are anxiously parsing out and reacting to each bit of economic news.
Nearly seven years ago, the Federal Reserve embarked upon unprecedented measures to save the economy from falling into a systemic economic depression. Short-term interest rates were reduced to essentially zero, while the Federal Reserve levered up its balance sheet by purchasing more than $3.7 trillion of Treasury and mortgage-backed securities.
The low interest rate environment was initially intended to keep liquidity flowing, but was also seen as a catalyst to spur future economic growth. Unfortunately, the US economy has only been able to achieve a 1.1% compounded annual growth rate over the past 7 years, a stark contrast to the 3-4% growth The Federal Reserve had anticipated. The silver lining is that in the past three years, the economy has grown on average by 2.35%. The low interest rate environment, however, did succeed in catapulting the S&P 500 to all time highs. Now, the overall concern is that raising interest rates will not only snuff out this historic bull market but will act as a headwind to the moderately growing economy. There is a school of thought that believes the hike in interest rates could actually encourage growth by freeing up savings and that could help offset the expected decline from rising interest rates.
I am not an economic soothsayer; I do not have a financial crystal ball or read the entrails of goats. In fact, all of my historic economic forecasting has been notorious for being too early, too late and just plain wrong. That is why Hazelton Capital Partners does not rely on economic predictions as part of its investing process. But that has not stopped the Fund from investing in economically sensitive industries like oil refining or gold mining. Our thesis for investing in these cyclical industries is uniform to our general investing mantra: Invest in companies operating in a niche segment of an industry that can maintain an economic competitive edge. Hazelton Capital Partners does recognize that a rising interest environment and a strengthening US dollar will negatively impact the business models for a number of companies, which is why the Fund has been proactively sidestepping these types of companies.
Hazelton Capital Partners – Top Five Holding: Tesco Plc
Tesco Plc is the third largest global retailer, behind Wal-Mart and Carrefour, and the largest in the United Kingdom. The nearly 100 year old company focuses primarily on the grocery and general merchandise market and commands a 30% market share in the UK grocery market. The company has retail operations in 12 countries in Europe and Asia, and since the 1990’s, has expanded its retailing to include books, electronics, clothing, furniture and financial services.
Starting in early 2014, Tesco began to run into some significant operational challenges, most, if not all, were of its own design. The company’s sheer size and recent focus on international growth (outside the UK) caused its management to become distracted and slow to react to changes in consumer spending habits. Discount retailers, like Aldi and Lidi, took advantage of Tesco’s slow response and began to encroach on its market share. By September, a new CEO, David Lewis, was brought in from Unilever to right the ship.
He began shrinking the company’s retail footprint by closing unprofitable stores and cancelling recent expansion plans. The cash raised from the sales and cost savings were to be used to reduce the debt on the balance sheet. But before Lewis could settle into the new job, he was forced to deal with accounting irregularities that had overstated profits by £250 million. Investors, already disappointed with Tesco’s declining market share, began to lose faith in the UK retailer, and by December 2014, its share price had declined over 50% from the beginning of the year.
In late November through early December, Hazelton Capital Partners built its position in Tesco. There is no doubt that the company’s new management faces significant challenges to return the company to profitability and growth. But it appears that management is taking the proper steps by first shrinking its retail footprint to match the current landscape and using cost savings to de-lever its balance sheet. One of the benefits of investing in a 100 year-old company like Tesco is that the sum of its parts is often priced higher than where the company currently trades. Tesco has an extensive land holding that has been depreciated over a number of years. On its balance sheet, Tesco values its property, plant and equipment (PP&E) at £24 billion but believes the market value to be well over £34 billion. Adjusting for the higher PP&E, the new book value of the company is over 35% higher than the company’s current market capitalization. Additionally, management’s decision to eliminate non-profitable stores will help resuscitate operating margins. With current margins less than half of what they used to be a few years ago, even a small positive momentum will go a long way in improving Tesco’s value and its share price.
Hazelton Capital Partners – Current Holding: Comstock Mining
In November of 2014, I presented Comstock Mining, a gold miner, at an investment conference. The title of the presentation was: “When is a gold miner a value investment?” Recently, Hazelton Capital Partners has been building its position in LODE, and even though Comstock is not currently one of the Fund’s top five holdings, I wanted to share my reason for investing in this particular gold miner.
A gold mine has often been described as “a hole in the ground with a liar standing next to it,” a definition attributed to and made famous by Mark Twain. Twain speaks from experience; before becoming “the father of American literature,” Mark Twain (Samuel Clemens) was a silver prospector on the very land which is now Comstock Mining. Many people are skeptical about investing in gold miners, and rightfully so. The industry has been rife with scams and scandals. One of the most memorable was in 1997 when the Canadian company, Bre-X Minerals, was found to be fraudulently overstating its gold reserves and more than $6 billion of market capitalization was completely wiped out. But Twain is also famous for saying: “I’ve never let my schooling interfere with my education.” So, when Comstock Mining continued to come across my desk, I decided to put my own bias of the mining industry aside and look at Comstock with fresh eyes.
Comstock Mining is a Nevada-based gold and silver miner operating in the historic Comstock Lode District situated between Carson City and Reno, Nevada. The Comstock District gained fame at the tail end of the California Gold Rush, when silver ore was discovered in 1857. At the peak, in 1874, there were over 400 different mining companies operating in an area that was approximately 7 miles long and 3 miles wide. By the late 1920’s, most of the mining operations had closed down as increasing mining costs and falling silver prices made mining uneconomical. Starting in 2003, the Comstock Lode District witnessed a revitalization as land owners, like John Winfield, consolidated their holdings into Comstock Mining (LODE). Winfield also provided loans to the company to be used for additional land acquisition and exploration drilling.
Over the last 5 years, the company has been building out the necessary infrastructure: Power & water supply, mining & processing equipment, heap pads and roads, in order to create a sustainable mining, processing and production operation. In 2012, Comstock Mining commenced commercial mining operations achieving its first pour. Recently, the company received the necessary permits to increase the amount of mineralized ore it can mine from 1 million to 4 million tons per year, as well as expand its Lucerne mining footprint to include the east side of the resource area. With its current run rate just shy of 40,000 oz/year, the new permits will allow Comstock to leverage its established infrastructure, ultimately increasing its yearly run rate beyond 70,000 ounces.
The most striking divergence between Comstock and the rest of the gold mining industry is its cost structure. Globally, the cost of mining has been steadily increasing while mining grades and yields have been in a progressive decline. By 2014, the all-in global cost to mine (mining, processing, production, exploration and capital expenditures to sustain and grow future operations) an ounce of gold was well over $1300/oz. Comstock’s costs have been moving in the opposite direction. In 2014, Comstock’s all-in cost averaged $1,243/oz and management has already guided 2015 all-in costs below $1,000/oz. Further declines are expected as the company continues to utilize its infrastructure and as new mining programs target larger and higher grades of ore deposits.
However. the true competitive advantage Comstock Mining has over other gold miners is its location. Not only does the company benefit from operating in Nevada, which historically has been and remains friendly to miners, but the company also operates in one of the best mapped, surveyed and geologically studied mineral resources in the United States. With 150 years of collective mining and survey data, combined with its own recent geological surveys, Comstock Mining exploration costs (the costs associated with finding new mineral reserves) is one of the lowest in the industry. In 2013, the company reported validated qualified resources (measured and indicated) and reserves (proven and probable) of 3.2 million gold equivalent ounces in 2 of its 7 mining resource areas (Lucerne and Dayton); doubling its previous survey of 1.6 million gold equivalent ounces. With exploration costs of $6/oz, Comstock’s decision to explore for new reserves is not influenced by the price of gold like its competitors. Currently, the company is in the midst of a year long exploration program which is anticipated to increase its supply of gold equivalent ounces from 3.2 million to over 4 million ounces.
So, to answer my question: “When is a gold miner a value investment?” The answer: When the company is not run like a gold miner. Most gold mining companies are established organizations run by industry insiders, people who have worked their way up through the ranks by emulating the “sins of their father.” Gold miners are infamous for leveraging up their company’s balance sheets in order to increase revenues. A fait accompli especially when mining and production costs continue to rise without any end in sight. Comstock Mining is a budding gold miner run by a pragmatic CEO who is focused on generating positive free cash flow, reducing debt, and has worked hard to cut the company’s all-in costs. Comstock all-in costs are in decline, its production run rates are advancing, all while the grade of its reserves continues to improve – the complete opposite end of the industry spectrum. Additionally, Comstock Mining has the added flexibility to be able to explore for new reserves while the rest of the industry remains sidelined, waiting for the price of gold to rise. Even though the company share price has been negatively impacted by the decline in the global price of gold, Comstock Mining continues to generate value for its shareholders. Time is not a friend to most gold miners, but for Comstock, time is the main ingredient to its future success. Over time, the company will be able to expand its mining production, continue to reduce its cost structure, generate higher levels of positive free cash flow, increase its reserves and improve its balance sheet. This, in turn, will lead to a higher valuation for the company and ultimately its stock price.
Investing in Hazelton Capital Partners
Hazelton Capital Partners was created as an investment vehicle, allowing those interested in long-term exposure to the equity market to invest along-side me. With a substantial
portion of my own capital in the fund, I manage Hazelton Capital Partners assets in the same manner in which I manage my own capital. The best source of introduction to potential investors in the Fund has come from those that have invested or followed Hazelton Capital Partners progress over the years. Introductions are both welcome and
In mid May, Hazelton Capital Partners will hold its annual partnership dinner. A future email will provide the day and time.
If you are interested in making or increasing your contribution to Hazelton Capital Partners or just learning more about The Fund, please feel free to contact me.
Please do not hesitate to call me at (312) 970-9202 or email me bpas[email protected] with any of your questions or concerns.