Do you have the same feeling as we do? Nothing but euphoria surrounding the growth stocks. With AI as the engine propelling the magnificent seven to unprecedented heights. Higher interest rates don’t seem to bother their stock prices. Analysts are factoring in enormous growth expectations of today against relatively risk-free discount rates. This results in spectacular price targets.
When you invest in growth stocks, you don’t rely on dividends; you don’t count on the value of underlying assets; you don’t rely on current free cash flow. You simply count on the company generating those free cash flows in the future, in other words, that the value will increase to the current price. Or even stronger, you hope that someone will pay more for your speculation tomorrow.
That is precisely the opposite of what we do. We seek out companies that are undervalued, companies that we are convinced the current price is simply too low for.
In its most extreme form, we’re talking about our value plays in our portfolio. Companies like Bonava, Nextensa, and Stellantis, to name three extremes, where we are convinced that the current stock price by no means reflects the actual value. With these companies, you count on the company to continue doing the same as today, and the market realizes that the price is not in line with the performance.
This stands in stark contrast to NVIDIA, Salesforce, or Adobe, where you’re paying 50 (or much more) times the earnings. Here, you are relying on the company to meet its growth expectations.
Compounders exhibit characteristics of both growth and value. In our portfolio, for example, you’ll find Smartphoto, Cake Box, or Tessenderlo Group. On the one hand, we don’t overpay. We have an aversion to paying too much. On the other hand, we are convinced that the company can grow at around 10% or more annually for an extended period. So, even if there is no rerating by the market (understood as multiple expansion), it is sufficient for the stock price to follow the performance to achieve a decent return.
Or, as Warren Buffett said on January 18, 1963 (more than 60 years ago, indeed): ‘Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.’
In November 1974, he reiterated this in Forbes magazine: ‘Draw a circle around the businesses you understand and then eliminate those that fail to qualify on the basis of value, good management, and limited exposure to hard times. … Buy into a company because you want to own it, not because you want the stock to go up. … People have been successful investors because they’ve stuck with successful companies. Sooner or later the market mirrors the business.’
For us, it is much simpler to focus our homework on finding value plays and compounders rather than growth companies. Estimating the future profits of tech companies, especially those driven by AI growth, we find too difficult, if not impossible. How do you assess that value? How do you analyze the profits of a technology still in its infancy? Is that growth expectation not too euphoric? No idea. What is certain is that we cannot, not now and not in the future.
Feel free to call us ‘old school’ if you wish. We need solid ground beneath our feet, real cash flows, real assets. Other things, we cannot evaluate
Let’s face it.
Nevertheless, an uneasy feeling creeps over us. All indices perform so well compared to value stocks. Indices perform well compared to the Chess Capital portfolio. What do you say after three years of mediocre numbers? What if you had simply invested in the S&P 500 at the start of our fund? A good choice, as it turns out after three years, the S&P 500 was the best-performing index. Your return would be approximately 33% higher.
Did we make a mistake then?
Now you can say that the other choice was the better one. But if we had to make the decision again three years ago to start a value stock fund, we would do it again with 100% certainty. Three years ago, that index was expensive, and today it still is. That analysis still holds.
The history we have witnessed unfolding is one of the many possible scenarios that could have occurred. There were many alternative histories that could have played out. Therefore, you can never judge a decision in the past based on the history that followed. A decision is not good or bad because a particular scenario unfolded, and not another possible scenario. The unfortunate part is that you only hear this statement from people who failed and never from the winners. The winners, of course, attribute their success to their skill.
Nassim Nicholas Taleb describes in his beautiful book ‘Fooled by Randomness’ how not recognizing those alternative histories deceives us. He first gives the simple example of earning $10 million with a game of Russian roulette. There are 6 possible outcomes. In one, you end up in the graveyard, and in 5 possible outcomes, you earn $10 million. Quickly earning that amount this way or slowly through a lifetime of hard work gives the same result for an accountant, but in terms of risk, we are on two different paths. Anyone can easily see that.
It becomes more difficult when the revolver of the Russian roulette is not visible. In reality, the source of risk (because that is the revolver) is not visible. So, you can unconsciously play Russian roulette without realizing it and classify it as ‘low-risk.’ We see wealth being generated, but we don’t know what causes that profit. As a result, more and more people join the game without any idea of the risk involved. As long as the trigger doesn’t go off, we continue to play carelessly, and everything seems very simple. In fact, those who do not participate may even appear foolish.
And what does the future hold? We don’t know. Only the past can be predicted correctly.
Do we want to adjust our investment approach? No way. We do know that, even though we may seem very foolish. And it might take a while before we appear smart.
Just because the three-year history proved us wrong doesn’t mean we are mistaken. On the contrary. It is our belief that the longer history works against us, the closer we are to the turning point. It’s darkest before dawn.
It is very ungrateful to adhere to an investment philosophy of ‘taking little risk’ to protect yourself from that bullet while the rest of the market celebrates at the AI party.
In general, there isn’t much applause for low-risk investing.
But how do those growth companies actually perform?
TTime for us to take another look at both the short and long history. Let’s first examine the recent past. The chart below was published on the yardeni.com website on September 11, 2023. It illustrates the performance of the S&P500 growth index compared to the S&P500 value index. The larger the number, the better the growth stocks performed.
We’re going back 30 years in time. As we said, the recent past.
The 1.0 line represents a similar performance for both indexes on a daily basis. You can observe that leading up to the year 2000, the infamous dotcom bubble caused growth stocks to outperform value stocks significantly, only to fall back afterward. From the Great Financial Crisis (GFC) in 2008, there followed a period of roughly 15 years where growth stocks consistently outperformed. Only in 2022 did a significant correction occur, and for a moment, it seemed like a turnaround in favor of value stocks might take place.
That was without considering AI. Artificial Intelligence absorbed all attention and funds since the launch of ChatGPT.
Investing in value stocks has made you seem foolish for about 15 years. Since we didn’t just focus on the simple ratios used to identify value stocks, we were doing even better than fine. However, since 2018, growth stocks simply moved too fast.
However, there is ubiquitous historical evidence that value stocks outperform growth stocks in the long term. Data spanning nearly a century in the U.S. (yes, excuse me, but the U.S. market does have the longest historical data) and almost five decades of market data outside the U.S. support the idea that value stocks have higher expected returns. Despite occasional disappointing periods, we maintain the belief that lower relative prices lead to higher expected returns. On average, value stocks in the U.S. have outperformed growth stocks by 4.1% annually since 1927.
Some historical context is useful to provide perspective on recent developments in history. We obtained this chart from the website dimensional.com, and it was published on their site in early 2022.
While the period of weak performance is disappointing for value investors, it falls within the statistical range of possible outcomes. Value investing is based on the premise that paying less for a series of future cash flows is associated with a higher expected return. That is the most fundamental principle of investing. It is our belief, and that principle is sacred to us.
At Chess Capital, we believe that we are best served by decisions based on solid business-economic principles (sound management with skin in the game, low debt, healthy margins, good return on capital, etc.). These common-sense principles are supported by an abundance of evidence. We have argued this point repeatedly, and we will continue to reiterate it.
How to value a company?
This simple question was posed to us during our last video call. At that time, we smoothly evaded it by stating that the question couldn’t be answered in 5 minutes. Simultaneously, we solemnly promised to come back with a more substantive answer.
The truth is, volumes have been written on valuation techniques, and expensive MBA courses are dedicated to the subject. There is no simple answer, but fortunately, Professor Aswath Damodaran has encapsulated these expensive MBA courses into a lengthy (and free) video series. He has also authored substantial works on valuation, but the foundational work is ‘Valuation,’ authored by three McKinsey & Co writers, now in its 7th edition.
So, we could once again simplify our response by referring to those influential works. However, even more remarkably, we dare to assert that you don’t really need that extensive knowledge with our investment approach. The standard works are heavily focused on precise valuation, often starting with an exact calculation of the cost of capital. This is then used as a basis for discounting future cash flows.
We are rather simple investors. We don’t find such precise valuation very useful. We estimate our cost of capital cautiously and, consequently, on the higher side. So, we gain little from a pinpoint determination, whether it’s 7.1% or 7.3%. Our entrepreneurial mindset tells us to take at least 10%, sometimes 12%, and even 15% as the discount rate if necessary. This is already a simplification – and an additional safety margin we incorporate – compared to the valuation gurus. After all, the higher the return you demand (or, in other words, the higher you set the bar for the cost of capital), the lower the valuation will be.
A second aspect we simplify compared to most is the projection of expected cash flows for the upcoming years. Many analysts conjure up intricate Excel sheets, preferably with numerous columns and rows. The impression is created that the more complex the calculations, the more accurate the valuation. Some even go to the extent of being precise up to three decimal places. This, of course, is nonsense. Whether a stock is worth €15.472 or €15.476 has no practical utility. It was Warren Buffett who taught his followers that he never uses an Excel sheet and that the best valuations are often done on the back of an envelope.
In summary: if a well-managed and debt-free company is worth, in our estimation, between €35 and €45 per share, and we can buy it for around €25, we believe we are making a good deal. There’s no need to make it much more complicated.
But first back to basics. What is the value of a company?
The value of a company is the sum of future cash flows, discounted to their value today. Reread this sentence if you have any doubts because it applies to everything that generates cash flows, whether it’s real estate with rental income, a cow producing milk, an ice cream shop selling ice creams, or a holding company with multiple sources of income like Sofina.
This method of valuation is known as the discounted cash flow (DCF) method, and we apply it to most of the companies in our portfolio. Essentially, we need two elements:
- The discount rate (for which we’ve already simplified with a minimum return of 10% or more if there’s more risk), and
- The cash flows we can expect.
So, let’s focus on those cash flows. We are interested in the cash flows that come to us as shareholders. Okay… the dividends, yes, but more than that.
Alright, let’s start from the beginning. A company generates profit. With that profit, it can compensate its shareholders in two ways: by paying dividends or by repurchasing its own shares. The latter is effectively a compensation to shareholders who retain their shares because future profits have to be distributed among fewer stakeholders.
But a company can also keep the cash in-house. That cash can be used for future investments or acquisitions, which, in turn, can increase future profits. Too much cash on the balance sheet can create an atmosphere of abundance and be detrimental to cost management. So, we appreciate seeing cash in the hands of CEOs who have proven they can use it wisely.
The free cash flow is thus more than dividends but possibly less than profits. This is because a growing company also invests. These investments, which it can depreciate over a longer period, may not be immediately reflected in the profit figures. In a growing company where substantial investments are made (in both fixed assets and working capital), the cash flow may be less than the profits. Conversely, in a mature company, the benefits of past investments may be enjoyed, and those depreciations then impact profits but not cash flow. Depreciations are a non-cash expense, and consequently, cash flows are higher than profits.
The essence of all the above is that determining cash flows is primarily not about numbers but rather a business story. It revolves around a solid understanding of the company you’re trying to value. What does the CEO do with the cash flows? How profitable were past investments? How much capital can the company reinvest to finance its growth? How much money does it give back to shareholders? Are they buying shares at an attractive price, or do they do it when the stock is very expensive?
We ask these and many more questions to arrive at a meaningful understanding of cash flows. Then, it’s crucial to err on the side of conservatism when estimating them. Overestimating growth can lead to overvaluing a company. We prefer companies that already generate attractive cash flows today and gift us the growth. Finding such companies, which we also want to buy much lower than their calculated value, is not straightforward. Only by turning over many stones do you occasionally find one that meets the necessary quality standards and is simultaneously inexpensive. Hence, value investing is a matter of great patience. Patience in searching and patience to wait until the market sees what you saw.
This method of valuation is particularly applicable to what we call ‘compounders,’ companies that generate free cash flows today and that we believe can sustain significant growth over an extended period.
Somero Enterprises
Let us illustrate with a very practical example from our portfolio. For those who prefer to stick to the general principles, you can continue reading from the next heading.
As an illustrative example, let’s consider Somero Enterprises. Somero supplies and maintains machines that can lay concrete floors with laser precision to a fraction of a millimeter. They are a top company in this particular niche within the construction sector. The company has a management team that has been at the helm for a long time and has made the right moves during times of crisis.
Over a period of 10 years, the revenue evolved from £37 million to £110 million. The gross margin was consistently very high, even improving from 52% to 56%. The operating profit margin grew from less than 20% to around 30%. All these figures confirm the quality story.
The net profit amounted to £20 to £35 million in each of the last 5 years. This year, we expect to be on the lower end of the range. From here, we calculate the cash flows. Roughly, we can say that the company depreciates about £1.5 million annually, invests £5 million in capital expenditures, and the working capital grows by about £1 million each year. So, in net terms, the company increases its capital by approximately £4 to £5 million annually to fund the impressive growth.
We can also examine the sales/capital ratio. For every invested pound, the company generates £3 in revenue. When we incorporate growth into our DCF model shortly, we can estimate our capital requirements for the future.
We also consistently consider the amount of reinvestment compared to profit. For Somero, the reinvestment rate is 15% (meaning the free cash flow is 85% of the profit). Again, these are figures that represent an average over the last few years.
Let’s now create a back-of-the-envelope DCF (Discounted Cash Flow) analysis.
We assume a £120 million revenue and a modest profit of £25 million as the basis for our calculations. Let’s say £25 million is a realistic figure. The revenue has grown by 9% and the profit by 11% annually over the last 5 years. We won’t overestimate and will assume a modest growth of 6% for the upcoming years and 3% from year 6 onward. For the infinite future, we estimate a growth around or slightly above the inflation level.
To discount to today, we use a rate of 12%, which is also quite conservative for a mature company. However, considering it’s in the construction sector and a niche player, we remain cautious.
The company has £21 million in cash and £2 million in debt. This yields the following very simple DCF.
This leads us to a present value of £5.8 per share. The stock is currently trading around £2.7. Suppose we were to buy today at £5.8; in that case, we would achieve a return of 12% if the estimates materialize. If the market agrees with us and converges to the fair price within three years, our return would be much higher, of course. In the meantime, we receive an annual dividend of over 10%.
Now, let’s consider what is known as a reverse DCF. We will examine the market price we are paying today and assess the assumptions that must be made to justify that price.
Well, to reach the current market price, the company’s profit would have to fall back to £15 million and not increase for 5 years, only starting to grow at a rate of 1.5% from the 6th year. Even under these conditions, we would still achieve a return of 12%. For us, it is clear that the current price is significantly undervalued.
Valuing holding companies
Valuing holdings is a different story. The future cash flows of a holding company are the sum of the cash flows from each of the underlying investments, which can be either publicly traded holdings or private equity. This is supplemented with cash and/or debts. Compare it to the valuation of Chess Capital. We are a simplified version of a holding company because each position is publicly listed, and we never incur debts.
But as an outsider, it is an impossible task to individually value each position and then aggregate the sum of the parts. How can valuing a holding be simpler than valuing a single compounder? Holdings can have a multitude of investments. So, in this case, it’s crucial to look at the management. How did they allocate capital in the past? What kind of companies do they invest in? How much debt do they take on? How risk-averse are they? How did they communicate in challenging times? And, if over a long enough period, what is their track record? In short, ‘trust in the management’ is the key idea.
When you invest in a holding, you rely on the knowledge and skills of the management to make the right decisions in the markets where they excel. That’s the way we operate as well. With holdings, we look at value creation over decades. To do this, we like to analyze the book value per share, augmented by the dividends paid per share. Why per share? Because this accounts for the buyback of own shares (or potential issuance) as well.
We have a fondness for family-owned holdings with a rich history. However, the consistent rule is that, just like all our other positions, we only acquire them when they are clearly undervalued. Holdings are also susceptible to sentiment and emotion. The most prominent holding company globally, Berkshire Hathaway, has traded both significantly above and below its ‘sum of the parts.’
Let’s take a closer look at Sofina, a case closer to home. For years, it couldn’t be budged above its net asset value – another concept that reflects the sum of the parts. Sofina was dubbed the sleeping beauty. The value was there, but it wasn’t being realized due to inadequate communication. From 2015 onward, Sofina became more transparent (when the stock was around €100) and rode the wave of private equity, particularly in their investments in tech companies with an exotic touch—investments that the average investor doesn’t have access to. Sofina became ‘the place to be,’ and the stock peaked above €430 at the end of 2021. However, a few smaller holdings had to confess to problems, and the stock went back to square zero, halving to below €200. Quite a substantial move for a holding. The market only saw the problems and no longer recognized the family Boël’s good holdings. For us, this was a signal to enter. With a discount of about 30% compared to the net asset value, we believe we are on the right side of the deal.
Value plays
Within this category, there are different ways of valuation. Let’s explore the three possible perspectives:
- The same approach as a compounder: Starting from the cash flows.
- Starting from the value of the assets: Similar to how holdings are valued.
- Starting from the probability of a specific event: Considering the likelihood of a particular event.
Let’s go through the scenarios here as well.
The first scenario, a discounted cash flow method based on cash flows, is entirely similar to what we discussed earlier. The difference is that we are content with the current cash flows, and we hardly or do not take into account possible growth. In some cases, we even assume that cash flows decrease. When the company is still priced cheaply under these conditions, we see it as an opportunity. Simply put, if you can buy something that costs 1,000 and generates 300 in cash flows annually, even if that cash flow halves, you still make a 15% return. The key is to assess whether the company is genuinely as weak as the market thinks. Here, you can find unique situations where a company emerges from a special circumstance, and the market doesn’t fully understand it.
Wickes
An example of such a special situation is the English do-it-yourself store Wickes. In April 2021, Wickes was spun off by its parent company, Travis Perkins. In a spin-off, shareholders automatically become owners of the spun-off shares, calculated at a fair value. This is generally more reliable than an initial public offering (IPO). In an IPO, the old owners receive money from new entrants, and they will try to put the shares on the market at the highest possible price. In a spin-off, there is no incentive to do so because the owners remain the same. Wickes went public at a price of £2.5. According to our conservative approach, the fair value has risen to £3.4 after 2 years. We entered when the price had dropped to £1.68. Today, the stock is trading at £1.37.
What happened? Wickes, with a market capitalization of £355 million, is a much smaller entity than its former parent holding, which has a market capitalization of £1.8 billion. Institutional shareholders can only hold larger companies in their portfolios, so they are compelled to quickly divest smaller entities like Wickes. This largely explains the decline in the stock price.
With Wickes, there’s another factor that the market is overlooking. The net profit last year was £21 million, resulting in a price-to-earnings ratio of 17 at the current price—not particularly cheap at first glance. However, Wickes carries buildings on its balance sheet that are heavily depreciated annually at around £100 million, while only £20 to £30 million is invested. Therefore, the cash flow is at least £70 million higher than the profit. So, we have a free cash flow of roughly £90 out of £355, or about 25%. Not bad.
While waiting for the market to recognize this, we are receiving an 8% dividend annually at the current price.
Bonava
In a second scenario, we won’t deeply analyze the cash flows but will focus on the tangible book value. This is safest to do with companies where the book value can be frequently and demonstrably measured and shows a certain level of stability. Current examples from our portfolio and a former investment can illustrate this.
Presently, we have Bonava in the fund, a Swedish homebuilder. The business case is straightforward.
Bonava currently has SEK 7.3 billion in tangible book value, which is all assets minus debts. The market value is SEK 2 billion. We assume that most small Swedish shareholders have sold out after the panic in the Swedish housing market.
The value of houses and land is regularly estimated, and these valuations are quite accurate because there are frequent comparable transactions. The reasoning here is that even if the prices of land and houses were to decrease by 20% to 30%, the company would still be significantly undervalued at the current price. Crucial in this analysis is the level of debt that the company carries. Such businesses rely on leverage since they don’t depend on exceptional returns. If the debt is too high, interest rates rise sharply, and significant repayments are due quickly; such companies can run into trouble. If you find a company that bears these risks to a low degree or not at all, it becomes a strong candidate for doubling its stock price in two or three years.
With Bonava, we assume that they can repay their debts promptly. The management is implementing necessary cost-cutting measures (they announced 300 layoffs last week) and has divested less profitable regions (such as Norway) or outright problematic ones (like Russia).
Euronav and Wereldhave were previously in our portfolio, and we acquired them at a significant discount compared to tangible book value.
A crazy story
Lastly, we have the category of optionality, or the chance that a particular event will occur. The uncertainty surrounding it can lead to asymmetric prices, meaning they are completely mispriced. We don’t have such companies in our portfolio. Therefore, I’ll provide an example from an acquaintance. Alright, it’s a bit eccentric, but very educational. Bear with me in this story.
In 2018, or thereabouts, news broke that oil had been discovered off the coast of the small South American country of Guyana. It was nothing more than a small article in the New York Times, but for Christopher, it was enough to look into it. It turns out that in almost 100% of scenarios, the country becomes suddenly wealthy. An ideal moment to invest there. So, he gets on a plane and heads to Georgetown to get a firsthand feel of the situation. There are also elections on the horizon, and it’s unclear whether the left or the right will win. This makes a significant difference in how that wealth will be spent. If the left wins, oil revenues will be used for infrastructure projects, and schools and hospitals will be built. If the right comes to power, the free market will be stimulated, and entrepreneurs will be attracted with tax reductions.
Regardless, the life of the ordinary person will undoubtedly improve. So, in 2019, Chris headed to Guyana to find that the stock exchange physically opens once a week to trade paper shares of about ten companies. He bought three shares from companies selling consumer products: a bakery, a rum producer, and one more. The stock prices of these companies have since averaged a threefold increase.
Here, the optionality of oil production was nearly 100%, but the outcome of the elections was highly uncertain. So, Chris chose stocks that were independent of the elections. This is not an example to be directly copied, but it’s a nice illustration of how you can think about the consequences of a virtually certain event in an uncertain environment.
Conclusion
Before you embark on valuation, it is essential to first understand the business case. A valuation exercise simply makes no sense if you don’t comprehend the business or have no affinity with it. For companies in which you want to invest for the long term, more is required—a kind of affection, you could say. You would, figuratively speaking, want to be the CEO of those companies, fully able to empathize with them.
Only when these aspects align well should you begin the valuation process. We realize that this is not a comprehensive course on valuation given the limited space. Still, we hope we have provided you with some insight into the way of working.
When we sum up all the conservatively calculated values of our companies, we see, for example, that about 70% of them are undervalued. Patience is the key to success. If we have done our homework well, sooner or later, the market price will grow to the intrinsic value. Meanwhile, we closely monitor whether our companies continue to perform as we have estimated.
The Fund
The past quarter was once again an example of market volatility, especially for our smallcap stocks. After a robust increase of almost 5% in July alone, we had to relinquish those gains in August and September.
The good news is that more investment opportunities are emerging. We have added several new stocks to our portfolio, reducing our cash position to 2.3%. As mentioned earlier, we view investments in holdings as buffer positions that we can liquidate if we need cash.
At this moment, HAL Trust is at the top of our list to sell if we want to free up cash. It was a good move to temporarily park the money here instead of holding it as cash, as we have made more than an 8% profit on it, despite the recent declines. HAL is currently our worst-performing buffer position. We bought Sofina because, in our view, it is way too cheap, and thus, for now, I consider it a genuine investment and not a buffer; I won’t sell at this price. Even with the substantial decline, it’s still marginally positive.
In short, there is still room to invest a bit more, but…
Now
As we have written multiple times, we absolutely do not try to time the market. You never know what exceptional events might be around the corner.
However, what we do see is that there are still interesting new stocks coming our way today, and we currently perceive many opportunities to invest. The strange thing about investing is that you actually make money when it seems like you’re losing money due to declining prices. However, this only becomes apparent when the prices rise, and as an investor, you find yourself twiddling your thumbs more often because there are too few opportunities.
In our view, now is the time to invest more. While we actually struggled against the rapid growth of assets under management in 2021, we believe that the coming half-year is the opportune time to make additional investments.
If I (Sam) could, I would contribute more, but Tasha and I have just bought a new house, and the renovations have cost more than desired, locking up the additional capital I intended to invest in the fund (terrible timing).
Because we (Joël and I) believe it is the right time and are convinced that we all benefit from an increase in assets under management, we are organizing an investor evening at the end of November for potential new partners. We aim to raise a maximum of around 25% to 30% of the current assets, approximately €5-6 million. If we can raise this amount, we will then hold of a bit to process it first.
We are notifying you in advance because we want to give our current partners, who have already placed their trust in us (thank you once again for that), the first opportunity to contribute more if they wish.
The difference between the fund’s price and what we calculate as the intrinsic value has widened to almost 80%. This is due to deploying cash and despite some downward adjustments, such as on positions like Nobia and Foot Locker. We have not adjusted some other positions where we previously wanted to increase the intrinsic value, to maintain an additional margin of safety.
In short, not only is it a good time for the fund to invest now, but it is also a good time, from the perspective of each individual, to invest in the fund.
Transactions
In the third quarter, we bought some new positions.
Semapa is a conglomerate with its main activities in paper and cement, but the emphasis is really on paper at the subsidiary The Navigator Company.
Both paper and cement are not exactly two attractive sectors and are highly cyclical. When valuing such companies, there is always the risk of extrapolating the results of a good period too far and thus overestimating the value. If I normalize the profit, the profit can decrease by 16% per year over the next five years, even from that lower point, and then stabilize to justify the current stock price. This is a typical value play where the stock price is simply too low, for an identifiable reason (economic cycle). Moreover, we have a potential price trigger here; the controlling family has tried to take the company private a few times.
KoneCranes and Maersk also find themselves in the same situation of economically sensitive stocks that, in our opinion, have now been unduly punished. Both are market leaders with very strong products. For example, Konecranes’ cranes (used in ports) are up to 30% more productive than those of their competitors. And I believe everyone is familiar with Maersk. What many may not know, however, is that they are increasingly becoming a full-service provider for logistics, not just for container transport.
Focusrite is a different story. This small company, engaged in audio solutions for musicians and sound professionals, is a potential compounder or core position. Focusrite’s products are top-notch in their sector, and they benefit from the growth of home studios and podcasts.
We bought a small position to get to know the company better. Liquidity is so low that if we want to increase the position, we must be 100% sure that this could be a long-term position (+7 years).
Since January 1st of this year until September 30th, these are the biggest winners and losers among the stocks that are still in the portfolio:
Since the inception of the fund (including before the merger), here is the performance of the companies that are still in the portfolio:
Our five largest positions and cash on September 30th were:
Results T-Class
The T-class was only opened in October 2021. Figures from before have been recalculated pro rata to the performance of the A-class. For your information: “T” stands for “Three” and symbolizes the three-year commitment.
The calculated intrinsic value per share for the T-Class is €1,515, showing a very attractive difference of 79.7%. The intrinsic value has decreased compared to the previous quarter, despite additional purchases. This is due to some downward adjustments and some positive adjustments that have been temporarily postponed for extra safety..
News core positions
We would like to keep you informed about the developments at the core positions.
In July, an Australian group made a bid for Cake Box at GBP 160 per share. This was immediately considered too low by the board of directors and the major shareholders. It was logically rejected. In a brief update, they also mentioned that the new fiscal year has started well with higher revenue and the opening of new stores..
Smartphoto achieved good results in the first half of the year, at least in our opinion, but the market responded less favorably. Revenue increased by 2.5%. However, the operating profit decreased by 2.3% due to increased costs. The net cash position grew from €2.08 million to €4.59 million.
The first half of the year is still not as significant at Smartphoto, even after the acquisition of the B2B company Nayan. Christmas and New Year, that’s what it’s all about.
The market also reacted disappointedly to Tessenderlo. I really can’t grasp the expectations some people have. Tessenderlo’s revenue declined by 4.7%, which is not surprising after the exceptional 2022 in the Agro department.
The operating profit decreased by 37.4%, and here too, higher costs impacted the result. This also seems unsurprising to us. Again, there is a net cash position of €13.3 million, whereas last year, there was almost €60 million in debt, despite nearly €100 million in investments.
Meanwhile, Tessenderlo is actively buying back its own shares, something we can only applaud at these stock prices. I wonder, though, who is still selling.
Deceuninck is also feeling the economic slowdown. Revenue decreased by 15.7% in the first half, partly due to exchange rate effects, but also because of a 7% lower volume, mainly in Europe and America, as Turkey performed well despite currency exchange differences.
However, the operating profit increased by 35.7% here, thanks to efficiency gains in North America and the strong performance in Turkey.
Somero Enterprises experienced a 14% decline in revenue, attributed to the slowdown in the construction market in the United States. On the other hand, there is a significant increase in revenue in Europe and Australia due to the expansion of sales teams in those regions.
In the United States, they see ample opportunities, especially with the billions in subsidies in the Chip Act, which will lead to substantial investments.
The expansion of teams led to a 29.6% decrease in operating profit. Somero is a true niche player and will quickly feel the impact of a slowdown in the construction market. However, they are robust enough to weather a more challenging period.
Next Meeting
We maintain the rhythm of quarterly video meetings. We are planning the next meeting on Wednesday, October 18th. Doors open at 7:15 PM, and the meeting will start at 7:30 PM.
Best regards and thank you,
Sam & Joël