October 30, 2017
Dear Partners,
Our fund posted positive results in the third quarter, bringing our year-to-date 2017 gross returns (before fees and expenses) to approximately +12%. Please check your statements as net returns vary depending on your investment date. We are long-term investors where our goal is to invest in companies we intend to own for at least 3-5 years. Nevertheless, our portfolio experienced an unusual amount of activity in Q3. Let’s go through our activity for the quarter one-by-one.
Sold: Novo Nordisk (NVO)
Novo Nordisk is a focused pharmaceutical company that is a global leader in diabetes care. We took advantage of an opportunity to purchase NVO stock after it had experienced a severe drop of ~43% in a matter of just a couple of months from late July to November 2016. The market was stunned by the continuously lowered sale and profit margins guidance for the year as investors were starting to get a view that the era of high profit margins could be gone forever as the drug pricing issues in the U.S. were not going away. This “pitch was right in our sweet spot” as we were able to pick up a stock in an outstanding company with a strong moat around their business, great management team, and at a very attractive price that offered us an expected double-digit annualized return over the next 5 years.
Only 10 months later, NVO has rebounded close to 50% by this September as investors were relieved to see that the sales stall the company had warned about last summer never materialized, and pleased to see hints of growth ahead. So much for efficient markets. (We strongly doubted that the intrinsic value of Novo Nordisk, a $125 billion company, had dropped 43% in just a couple of months last summer, and then suddenly went up 50% over the following 10 months.) Although we intended to hold NVO for many years, we decided to lock in our gains as the stock had quickly rebounded to levels that now only offer low single digit expected returns. The proceeds from the sale were reinvested into significantly higher expected return opportunities.
Sold: Rolls Royce (RYCEY)
We had just revisited out investment thesis for RYCEY in our Q2 2017 letter. The stock continued to climb upwards following our letter. We made a decision to sell our position at the end of August and realize the 31% gain that the stock had posted over a holding period of about 24 months. Our rationale was that the stock had gone up to levels that offered us an expected annualized return for the next 5 years far inferior to other opportunities we have in our portfolio.
Sold: Vista Outdoor (VSTO)
This was a small position we initially acquired back in 2015. VSTO is a leading global designer, manufacturer, and marketer of consumer products in the outdoor sports and recreation markets. We had been contemplating selling this position since the beginning of the year, admitting that we probably made a mistake. The latest news in June on management “transition” was the last straw that “broke the camel’s back.”. The board was trying to put a positive spin on the CEO’s “early retirement”, labeling it as a smooth transition, but our view was that it is anything but. After following this company for the past 2 years, our read between the lines was that the board fired him because the company is facing a difficult situation and was possibly at odds with their long-term strategy. All-in-all, we lost about 7% on this small position over our holding period, decided to take our money off the table and move on to more attractive opportunities.
ADDITIONAL PORTFOLIO COMMENTARY
As far as our buy activity, we started two new positions over the third quarter. This brings us to total of four new ideas in 2017, which is a bit of a higher level of activity than the 2-3 ideas per year we normally expect to generate.
We are now fully invested as our portfolio cash is down to about 2% of the overall portfolio. It’s worth noting that our fully invested portfolio is not a “market call”. We are by no means trying to predict what the market is going to do next quarter or next year. This portfolio came about strictly from our bottom-up research as we have been able to find a number of attractive investment opportunities for our portfolio over the past 12 months. We are happy to stay fully invested as long as our portfolio companies maintain their favorable long-term prospects and as long as their valuations remain reasonable, thus allowing us to compound your capital at double digit long term expected returns.
Thank you for your confidence and trust in our investment discipline. Should you have any questions or comments, we would be very happy to hear from you.
Sincerely,
Alex and Joe