Feature interview
Fishtown Capital is an individual investor and family office principal with over 20 years of investment experience. We discussed why we’re in the early innings of a rotation from growth back to value, why a stock being “cheap” isn’t enough, and the importance of looking at enterprise value for deep value names.
Seeking Alpha: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?
Fishtown Capital: I try to focus on areas of the market that I can understand and where I hope to either spot a trend early or see some kind of a mispricing. I tend to stay within energy, materials, and industrials, along with consumer discretionaries and staples. Within this, I usually focus on smaller names since mispricing is more likely to occur in those names, as a significant mispricing in a mega-cap stock like Apple or Google with dozens of analysts is far less likely to happen.
I actively avoid shares where I consider myself the “dumb money”, which is anything in pharma/biotech/healthcare, along with most real estate/REITs. I also try to avoid sectors that have historically been value traps despite being optically “cheap”, like auto manufacturers, and industries that have narrow moats and poor economics, like airlines and telecommunications companies.
From there, I’m event driven and look for things that happen that I believe the market is getting wrong. My favorite thing to look for is when there is fundamental improvement, but a share price remains depressed due to a weak broader market or even better, forced uneconomic selling. Part of the reason I believe I got into Cenovus at such an attractive valuation late last year was because ConocoPhillips was liquidating a 15% stake in the company in a relatively short timeframe.
SA: At the end of 2021 you made one of the best macro calls for 2022 (bullish on energy and cautious on technology) – what is your macro outlook (across one or more asset classes) for 2023?
Fishtown Capital: I think 2023 is going to be another tough year for the stock market. Some investors expect a rebound because the S&P500 dropped 18%, but I’m not overly enthusiastic. Valuations may not be as extreme, but they are far from cheap, and the TINA trade (There Is No Alternative) is no longer in effect as investors can get reasonable returns in fixed income for the first time in a while.
2022 was certainly a year in which extreme valuations came down to earth- notably in tech but in other sectors as well. But otherwise, the overall economy in 2022 was still very strong. We haven’t seen many companies warn on earnings, slash expectations drastically, or announce major layoffs yet. The labor market is doing well. So while the Fed has been hiking and that has impacted valuations, outside of a few industries like real estate, I do not believe we’ve really seen the economic impact of the Fed rate hikes yet.
2023 is the year where this may change. The Fed has never raised rates this quickly and it’s doing it after many years of very low interest rates. Debt levels are historically high as a decade of lower rates encouraged borrowing. I think the current situation is relatively unprecedented, and I also believe the probability of a soft landing is low.
That said, I do think inflation is getting under control quickly. I also believe the Fed is going to be forced to move short term rates down sooner rather than later because of the US fiscal situation. Interest on public debt, most of which is short term, is set to become the biggest line item in the national budget, even more than the military. So I think the pressure for the Fed to move short term rates back to the 2.5-3% range will be immense. If this happens, it’s likely to benefit fixed income.
Fixed income investors have underperformed stock investors for a long time and were burned further this year as “safer fixed income assets” performed as badly or worse than stocks. The 10 year Treasury was -16.5% this year, almost as bad as the S&P500 at -18%. Longer term treasuries did even worse. The Vanguard Long Term Corporate Bond ETF (VCLT), which holds mostly investment grade corporate bonds, fell 25%!
So, my Macro call for next year is less stocks and more fixed income. I think VCLT outperforms the S&P500 next year. I also see a lot of value in preferred shares that have fallen far below par and are now yielding 9-10%. Those issues could be major winners if short term interest rates are reduced later next year.
SA: What valuation and/or operating metrics do you find most/least useful and why? What are best practices for valuation analysis or financial modeling?
Fishtown Capital: When it comes to valuation, I look at things from a high level and don’t have hard and fast rules. I very rarely “screen” for stocks based on a given operating metric. I think combining a high level quantitative view with a qualitative understanding of what drives a given stock yields the best results.
When valuing a business, quality obviously matters a great deal. Looking back 10 years ago, Apple traded at low teens earnings multiple and many commodity producers with high CapEx requirements traded a 8x mid cycle earnings. Despite a higher multiple, Apple was the clearly superior choice. But what about now, with Apple at 20x and many of those same commodity producers at 3-4x?
When it comes to operating metrics, I always focus on cash flow for a business, and the drivers between cash flow and stated earnings. Especially with deep value plays, I look to find a catalyst that will drive a rerating. Generating lots of cash to either repurchase shares or debt is often a great way to do that.
Beyond that, I think the best practice for analysis and modeling is to keep it simple, and don’t try to model more than a few years out. If the investment case isn’t obvious after more than a few years, it’s probably riskier than it looks.
SA: It is difficult for some investors to buy a stock that is already up significantly (they “missed the move”) – are there other metrics they should look at besides price to see if there is an opportunity left? Can you give an example of a time you bought a stock that was already up significantly and it turned out to be a great trade?
Fishtown Capital: Rather than looking at a metric, I think it’s far more important to understand why the stock moved. Has something fundamental changed that deserves a permanently higher valuation, or is it temporary noise that’s likely to mean regress? This sounds easy in theory but is harder to do in practice.
With deep value names, I’m always a proponent of looking at Enterprise Value rather than the stock price. One of my largest positions, Cenovus, is up 58% this year. But its Enterprise Value is up only 27%, since it has used the overwhelming majority of its free cash flow to pay down debt and repurchase shares. So I’m more comfortably holding onto Cenovus at $20 than I would be otherwise because of this.
ZIM Integrated Shipping was a huge winner for me this year, but I bought it at $40 in October 2021 after it had already tripled in the previous 9 months. While their enterprise value had certainly increased, it was way less than a triple, since they used all the cash flow to repay $1.2 billion of debt in 3 quarters. The way I modeled their numbers, if container shipping rates stayed high, they would cash flow their entire enterprise value in about 5 quarters. 6 months later, shares peaked at $88, and I sold a few days afterwards for a double.
SA: You have >20 years of investment experience – how has value investing changed since you started? Do value investors need to change their approach entirely, in part or not at all due to the current environment?
Fishtown Capital: I don’t believe value investing has changed, it’s just underperformed and as a result, has fallen out of popularity. I think the current environment favors value investors and will for the foreseeable future. Value stocks actually did well this year – VTV (Vanguard Value ETF) is only down around 5%, versus over 30% for the NASDAQ.
It’s hard to extol the virtues of value investing when big tech companies go up 30% year after year, but I think we’re in the early innings of a rotation from growth back to value. The basic idea of buying something undervalued (the proverbial buying a dollar for 50 cents) I don’t think has changed. It was just too easy to make money other ways.
SA: How important (if at all) is identifying why a stock is down (or the mispricing or what the market is missing) before investing? Can you give an example?
Fishtown Capital: Like most investors, I hate losing money. In studying the psychology of investing, I know that as soon as you’re down money on a position, it triggers all sorts of negative emotional responses that increase the odds of making an investment mistake. So I really try to “buy at the bottom” even if it means I’ll miss opportunities if a company never gets where I want to buy them at.
But in order to know whether something has hit a bottom or not, it’s critical to understand the reasons why the stock is there, and why it’s likely to change soon. The stock being “cheap” isn’t enough for me. Cheap can always get cheaper. People were yelling about Facebook being “cheap” all the way from $240 down to $90.
My favorite example of this was H&R Block. Shares had been rangebound between $23-29 before COVID. COVID happened, this and everything else hit a crisis valuation, but H&R Block recovered almost back to $20 by June 2020. Then they released their fiscal 2020 earnings, which were predictably weak since the IRS changed the filing deadline. Shares tanked. Was this the year everyone had learned to do taxes themselves, or had the revenue just shifted into the next quarter? The next quarter’s results were released and it showed the business had just shifted, and even grew a little! Shares likely would have rallied, but almost coincident with their earnings, the S&P500 booted them out of the index, leading to forced selling.
This was one of the best opportunities in my investing career. I made H&R Block my largest position at 20% of my portfolio, and in hindsight, should have made it even larger. Understanding the reasons why the stock was down was the critical reason I had the confidence to make a boring tax preparation company my biggest position.
SA: What’s one of your highest conviction ideas right now?
Fishtown Capital: While it’s a bit more risky than some names I’ve invested in because of its debt load, Genesis Energy seems like too compelling of a value to pass up.
Genesis has 4 segments, but two of them contribute the bulk of the EBITDA, Offshore Pipelines and Sodium Materials and Sulfur. I’m extremely bullish on both businesses.
I believe the economics of Offshore GoM energy continue to improve compared with shale drilling and will benefit Genesis for many years. These pipelines are long lifetime assets (50+ years) that would cost far more to build today than what they are carried for on Genesis balance sheet. The already contracted projects provide a clear runway for this business over the next 5 years, and I believe there will be more infield drilling within Genesis’s system that will provide additional dollars at minimal capital cost.
Sodium Materials and Sulfur is even better and will benefit from the electrification trade, both via glass manufacturing (solar panels) and copper mining. I believe this segment alone could be worth nearly as much as the company is valued for today. Their closest comp to this business, Sisecam resources (SIRE), returned 35% this year.
This year, Genesis had two “beat and raise” quarters, guided to a strong 2023, has retained the majority of its cash flow to internally fund CapEx, yet shares finished the year down 14% (and were down 23% just a week ago when I initiated my position.)
I think the market is mispricing this (and most MLPs) because of some forced selling from foreign holders due to an IRS tax law change in publicly traded partnerships, coupled with investor reluctance to open K-1 positions late in the year. I love the story here, and expect a very big January out of Genesis Energy.
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Thanks to Fishtown Capital for the interview.
Fishtown Capital is long CVE, HRB, GEL
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