The Rational Cloning: Weekly Ideas #16
LRT Management's Top 10 Positions, YAVB on Cheap Cyclicals/Sporting Goods Retailers, Kuppy on The Great Rotation
Welcome to the 16th edition of the Rational Cloning Newsletter (Weekly Ideas Series).
Helping you discover the best ideas of others.
Happy cloning.
Weekly Investment Ideas
(1) LRT Capital Management December 2021 - Investor Update
LRT seeks “invest in a diversified portfolio of high quality companies, purchased at reasonable valuations, and hedged with market indexes to reduce volatility”.
Or a “A MOAT to protect returns, A BOAT full of re-investment opportunities, A GOAT or two running things, and A QUOTE that’s reasonable”.
LRT describes its top 10 positions, which I think make for a great hunting ground for new ideas.
Top 10 Positions (as of 1/3/2022)
#1 - Domino’s Pizza, Inc. (DPZ)
Domino’s Pizza is the world’s largest franchisor of pizza restaurants with over 13,800 locations in 85 countries. As for any restaurant operator, the key metric to consider for Domino’s Pizza is same-store-sales (SSS) growth. Growing same-store-sales are ultimately how a restaurant business increases earnings from its existing assets. The company continues to impress in this criterion with SSS having grown in the U.S. for 40 consecutive quarters, and an astounding 109 straight quarters internationally.
Domino’s Pizza stock is not optically cheap based on forward earnings, however, the company has routinely reported earnings growth of over 20% in almost all quarters since 2009. Given the company’s high growth rate, international growth opportunities, and capital light business model, which allows for returns on invested capital of over 40%, we are happy to continue to hold the shares.
#2 - Watsco Inc. (WSO)
The company distributes Heating Ventilation and Air Conditioning equipment (HVAC). The HVAC distribution business is approximately 80% replacement / 20% new construction
Watsco is the largest player in a very fragmented industry. The company earns mid-teens returns on invested capital and pays out most earnings in the form of dividends. The company also expands through acquisitions over time, buying up smaller independent HVAC distributors. Most recently they have acquired Temperature Equipment, a Chicago based distributor88.
Watsco also has the most unique long-term compensation policy for senior executives we have ever come across in corporate America – all stock grants vest at retirement or after 10 years, whichever comes later. This makes managers extremely long-term focused, something we believe is a real benefit for a company that grows primarily through acquisitions. We believe the shares are attractive at current valuations given the extremely predictable earnings the company enjoys, recession proof nature of the product and long growth runway. GAAP earnings are understated due to the amortization of intangible assets related to prior acquisitions.
#3 - Marriott International, Inc. (MAR)
Marriott is the world’s largest hotel company followed closely by Hilton (HLT) and Intercontinental Hotels Group plc (IHG).
Like all franchise-based businesses Marriott requires very little capital to grow as it utilizes the investment capital of its hotel-owners/partners to expand. Marriott currently faces a difficult operating environment due to the Covid-19 pandemic and uncertainty about the future of business travel. However, the company is an excellent operator with a somewhat leveraged capital structure (the company acquired Starwood Properties in late 2016) – if pent-up demand for travel materializes post-Covid, as we expect it will, the company will quickly go from losing money to raking in profits.
#4 - Novo Nordisk A/S (NVO)
Novo Nordisk is the global leader in insulin, which is, sadly, a growing business as more and more people around the world suffer from diabetes.
The company’s proprietary product line supports returns on invested capital of over 40%, and while sales growth is relatively slow (+6% annualized CAGR over the past decade), the company’s shares trade at a reasonable valuation of only 22x forward earnings. For a company with an extremely predictable business, high returns on capital, and an easily forecastable future, we believe this to be highly attractive.
#5 - Hexcel Corp. (HXL)
Hexcel manufactures carbon fiber composite materials with the primary end markets being aerospace and defense.
Just as is the case with Marriott, we do not view recent results as meaningful or indicative of a long-term trend, but rather a once in a century aberration due to the Covid-19 pandemic. Once Covid-19 recedes, we expect the demand for more fuel-efficient planes to return rather quickly, powering the demand for the company’s light weight carbon composites.
#6 - Texas Pacific Land Trust (TPL)
Formed out of assets of formerly bankrupt railroads, TPL controls the largest acreage of land in the Permian basin – the center of the US shale oil industry. The company has two main sources of income: 1) royalties from oil & gas extracted on its properties – essentially a free call option on future oil prices and production; and 2) a water business which develops water resources and sells services to the fracking industry. We see TPL as an effective way to diversify the portfolio into a commodity exposed business that has a history of smart capital allocation and low risk of financial distress during periods of low oil prices. The company has no debt, and $281 million in cash.
#7 - Repligen Corporation (RGEN)
Based in Waltham, MA, Repligen makes equipment for the biologic drug manufacturing industry. The company’s main products are focus on filtration (48% of revenue), chromatography92 (20% of revenue), process analytics products (9% of revenue), as well as select proteins used in the manufacturing of biological drugs (22%)
Under CEO Tony Hunt, Repligen has successfully reoriented itself away from selling commoditized inputs to the biological manufacturing process, towards selling specialized proprietary equipment – largely accomplished through M&A. Revenue grew at a CAGR of 22% before Tony joined the company and at 41% since then. Importantly, this growth has not come at the expense of margins or ROIC, which have remained very strong throughout the period.
#8 - Colliers International Group Inc. (CIGI)
Colliers International Group is a commercial real estate brokerage and investment management company founded by Jay S. Hennick in 1976 in Toronto, Canada.
The company believes that about half of its revenue is recurring in nature.
Colliers has historically grown by acquisition and we expect it to continue to do so. The real estate services market is highly fragmented outside of North America presenting ample opportunities for Colliers to continue its growth strategy. The company has been a good steward of shareholder capital and spun out FirstService Residential (FSV) in 2014 to maximize the value of that business.
#9 - Credit Acceptance Corp. (CACC)
Credit Acceptance Corp is a very controversial company as it is a subprime auto lender known for aggressive collection and repossession tactics.
The company’s high returns on capital and disciplined capital allocation have produced outstanding results for shareholders – over 20% annual returns for over 20 years (we are in rarefied air here).
The company remains controversial, operates in a highly regulated environment and is subject to periodic investigations and government fines. Some politicians have advocated banning subprime financing outright.93 While we recognize the risks, we are happy to hold the shares for now given the company’s attractive valuation and favorable risk-reward.
#10 - Asbury Automotive Group, Inc. (ABG)
Asbury Automotive Group is one of the largest automotive retailers in the United States. It operates 90 dealerships consisting of 112 franchises and 25 collision repair centers. The company’s stores offer new and used vehicles, parts and service, as well as finance and insurance (F&I) products.
ABG is not a fast-growing SaaS business, but when paying a valuation of ¼ of the overall stock market, one does not need to make heroic assumptions about the future to enjoy strong returns as shareholders. We believe that over the next several years, Asbury will continue to acquire dealerships, occasionally buyback stock and invest to improve its digital shopping experience.
(2) YAVB: What am I missing with cyclicals?
We talked about extremely cheap cyclicals trading at 1x PE in last weeks issue “Issue #16: Twebs on the Double Dog Index (Pabrai’s "PE of 1”) | LT3000 on Contrarianism, ESG Investing, and Coal". This week, YAVB published his thoughts on this grouping as well.
… the main thing I’ve spent time on this week is looking at stocks that are really cheap and buying back shares… Cyclical commodities trading for low multiples
The overall thing I’m seeing is that these companies are trading for super low multiples to trailing earnings while generating an insane amount of cash flow that they are generally returning to shareholders… I’m seeing commodity companies that have been minting cash flow for the past ~6 months but are trading at insanely low valuations / haven’t seen their stocks budge despite the record cash flow.
X printed $2B in EBITDA in Q3 and another $1.65B in Q4 (for comparison, this is a business that did $711m in EBITDA in all of 2019 and ~$1.8B in the first half of 2021, so these are bonkers quarters for a company with a ~$11B EV heading into them). That EBITDA generation leads to an insane amount of cash flow (cfo less capex in Q3 alone is ~$1.3B, or >10% of X’s EV in one quarter).
X’s peer CLF might have a little baggage, but you’ve seen multiple insiders buying on the open market in Q3, the stock is trading for a low single digit EBITDA multiple, and they have long term contracts that give them visibility into a great 2022.
Andrew Carreon made a great pitch for BSM in June. Recall that BSM gets paid royalties for oil / Nat Gas found on their land, so they’re a double beneficiary of rising prices (they get paid directly from more royalty dollars, but higher prices also encourages more drilling on their land). Since that pitch, oil and nat gas are both up ~15%., and BSM’s Q3 earnings call included quotes like “we have a lot of positive momentum around the asset base” as well as tons of discussion of all the new production that’s set to come online. Despite that, the stock has barely budged.
RFP currently trades for ~$14/share. They probably earned >$6/share in 2021, they have a reasonably aggressive share repurchase program (they bought back 7% of shares over the twelve months ending Q3’21) in addition to paying out nice sized special dividends, and I believe they would earn their entire market cap if lumber stays around current levels for an entire year.
UAN will likely earn and pay out 50% of its market cap in the next three quarters.
(3) YAVB: What am I missing with retailers: sporting goods edition
He also published his thoughts on retailers.
Today, I wanted to talk retailers. I think there’s a really interesting opportunity; there are tons of retailers out there that are trading for mid-single digit EBITDA multiples while gushing cash flow and buying back shares like crazy.
Let me start with my current favorite: the sporting goods companies. This includes Academy (ASO), Dicks (DKS), Hibbett (HIBB), Sportsman’s Warehouse (SPWH, which I mentioned last month when their merger fell through), and Big Five (BGFV). You could even loop Foot Locker (FL) in there if you really wanted to; I will include them just to add another cheap retailer even though the FL dynamics are dramatically different than those other companies. All of these are trading insanely cheap; on a LTM (last twelve months) basis, the most expensive one I see is DKS, which trades for ~5x LTM EBITDA and ~6x LTM UFCF (defined as EBITDA less capex). BGFV and FL are the cheapest, trading for <3x EBITDA. (PS- all of these companies are using Q3’21 balance sheets, which includes inventory build for the holiday selling season. Adjust for that, and they’d all be incrementally cheaper).
The one other thing I wanted to hammer home is that it appears insiders believe that COVID has permanently improved their business.
The obvious place we’re seeing that action is in share buybacks / capital returns, and I’ll discuss that in a second. But I first wanted to mention the insider purchases here. We’ve seen multiple insider buys at HIBB, SPWH, and Dicks in the past couple of months. The Dicks one in particular was enormous…
On top of those insider purchases, the companies are being very aggressive with capital returns across the board (the only exception is SPWH, who was precluded from doing capital returns given their failed merger. I expect they will aggressively return capital in the near future). ASO, DKS, and FL have all bought back 5-10% of their stock in the past year (and DKS and FL have paid out a nice dividend), but the headliner here is clearly HIBB. I’ve taken a screenshot from their Q3’21 10-Q below; it shows they bought back ~1.3m shares of stock in the month of September. HIBB had ~15m shares outstanding heading into that month, so in one month HIBB bought back almost 10% of their shares (and note the price is ~20% higher than HIBB’s current price!)!
I’d expect all of the companies to remain aggressive with repurchases going forward. Again, they are gushing cash flow, insiders seem to think they’re cheap, they are telling the market they are going to repurchase share going forward, and (perhaps most importantly) their historical actions suggest that they will follow up on their words.
(4) Kuppy: The Great Rotation
We love Kuppy. Original, bold and contrarian investing ideas. Definitely worth a read.
Favorite quotes are:
“…inflation is about to awaken all these PMs from their slumber”
“…the whole periodic table will go positively mental”
“…these will need capital spending; roads, pipelines, infrastructure, electrical grids, ports, airports, and public transport. All of this will absorb stunning amounts of commodities...”
My bold prediction for 2022 is that we’re about to have the mother of all sector rotations. On one hand, the Tiger-40 will get sold off—on the other hand, the “old economy” is about to absolutely roar.
I think inflation is about to awaken all these PMs from their slumber. In a deflationary world, you can pay almost any price for future growth. When inflation rages to the point that the Fed is forced to act, all you want is current cash flow, not 2050’s cash flow discounted back.
Why can’t oil companies trade at a few times PV-10? If people think oil is going to a few hundred, why shouldn’t they trade at massive premiums?
What about financials? What if people suddenly expect a yield curve? What if banks can earn an actual yield on deposits?
Look at industrials. What is a factory worth if a new one costs five-times as much and takes 10 years to permit? We’re re-shoring all sorts of production, where’s it going to be produced?
There’s massive supply chain issues—these will need capital spending; roads, pipelines, infrastructure, electrical grids, ports, airports, and public transport. All of this will absorb stunning amounts of commodities and lead to fat margins throughout the process.
Politicians are now demanding that we have a transition into a “green” economy. Whatever that means, they’ll fund it all. Where will the basic materials, the commodities, the components come from? This is going to all be wasteful government spending—don’t you think the margins will be excessive? If they even go through with a tiny piece of what they’re talking about globally, the whole periodic table will go positively mental.
What’s a copper mine worth when it takes a decade to build a new one? What about a cobalt mine? All these boring, old, dirty businesses are about to have a decade of excess profits. The governments of the world intend to print the money and spend it—inflation be damned.
Tweets That Make You Go… Hmm 🤔
