First quarter 2017 result – Balmoral Fund
It has been a productive start to the fund with some excellent investments made at good prices. In general markets are a little expensive judged historically however some mispricing in markets has taken place due technical and sentimental reasons which has provided us with some great opportunities.
From fund inception on Australia Day 2017 to the end of March, after fees, investor units have increased in value by 3.79%. Over the 64 days the fund has been operating that translates into 20.97% annualized rate of return.
The portfolio continues to take shape with the fund currently 53.5% invested in shares (of which 46.8% are international companies and 6.7% Australian) with the residual 47% still held in cash awaiting investment (cash is broken down into 16.1% held in US Dollars, 7.4% held in Euro and 23.5% still in Australian Dollars).
The 53% of the fund invested in shares is spread over 7 companies. Each was selling at an attractive price at our time of acquisition, so two powerful foundations were in place; these businesses each have the products and market positioning to earn greater than industry profit margins over the long term, and we acquired them well.
Coty Inc: US beauty group Coty Inc. owns brands including household names like Chloe, Marc Jacobs, OPI, Rimmel and Wella. They are the world leader in fragrances, global number 2 in salon hair and they are growing their presence in body and skin care. The Coty share price has been beaten down recently for three main reasons; the company just completed a major acquisition of beauty brands from Proctor and Gamble (P&G) which can bring corporate indigestion, it recently changed its CEO, and post this major acquisition the company informed the market its acquired businesses had more inventory than it was expecting and as a result it wrote down the value of some of the inventory. Coty shares lost some of their luster and temporarily misplaced around a third of their price over 2016 – which provided us an attractive entry point. What should instead be focused on is the sales growth potential of these leading brands (which were neglected as non-core at P&G) and the high profit margin / inflation protection characteristics the beauty industry enjoys. Although the share price is down slightly from our acquisition price the newly aggregated business will need time to integrate and build momentum across its larger footprint. Over a 5+ year horizon this excellent business should contribute handsomely to the portfolio.
Villeroy & Boch: 9% of the fund owns German premium porcelain and ceramics group Villeroy & Boch. This 267 year old company has long been seen as best in its field and it even completed a commission for the Titanic. The company’s longstanding reputation for uncompromising European quality remains and this enables it to generate sustainably attractive profit margins. We acquired the shares at an attractive price simply because geopolitical concerns (ie the Italian election and BREXIT causing anxiety about the future of the EU) meant investors were selling European assets and European households were saving and not spending on expensive porcelain due to concerns about their jobs. Over 2017 geopolitical risks like the French and German elections will continue to influence market sentiment however out into 2018 and beyond the standout nature of this company will reflect in the market valuing its earnings potential more favourably. Equally domestic European demand will recover and with a weak euro currency exports could add a tailwind to sales growth.
Inwido AB: 8% of the fund owns leading Swedish windows producer Inwido AB. This company was founded in 1811 and has more recently embraced technology allowing its windows and doors to be planned directly into building designs through widely available planning software. This ease of planning/implementation for interior designers, architects and builders, combined with their reputation for quality and durability earned over many years keeping out harsh Scandinavian-winters, means Inwido is now accelerating its sales growth on a strong sales platform.
Hugo Boss: 7% of the fund owns German 93 year old premium clothing company Hugo Boss. This company’s corporate apparel sales slowed in recent years due lack of investment in the marketing and proposition. New management has refreshed the strategy with the existing dominant BOSS business wear lines getting refreshed as the cashflow engine while a new high-end casual brand Hugo, which takes advantage of the excellent leverage on their existing distribution relationships and brand affiliations with quality and professionalism, brings the company its sales growth potential.
Prada: 7% of the fund owns a part of 104 year old Italian luxury brand company Prada. Like Hugo Boss Prada is a bit of a neglected treasure and arguably has lost its way in recent years. Despite that lack of focus resulting in its share price more than halving in recent years the business remained extremely profitable and it has no debt. The 67 year old matriarch Miuccia Prada, who took over this small family leather business in 1978 and delivered its first blockbuster product, the black nylon bag, in 1985 then went on to build a global fashion powerhouse, has a long way to go before she recedes into history. Given the subjective nature of fashion it is hard to determine when this iconic business will fire again, however the downside from here is limited (a competent management team could run the business as a cash cow with only modest capital investment) while the upside is highly attractive. For example when the business next delivers a new ‘it’ bag, or if it can regather its top-end desirability in fashion, this investment would quickly turn into something special. The intent with this position is to be patient and let the business rediscover its magic.
Deutsche Bank: 7% of the fund owns a part of Deutsche Bank, the dominant banking powerhouse on the European continent. Deutsche Bank was poorly positioned leading into the Global Financial and European Sovereign Debt Crises. The business laboured under enormous complexity which in turn resulted in multiple expensive and embarrassing problems which have diverted management attention and scared away shareholders. A bank is a highly leverage business (it borrows many times its capital in funding so it can extend loans) and so small errors with its borrowed money can quickly eat up the limited underlying capital. A new British CEO (John Cryan) was appointed in mid-2015 to clean the business up and refocus its operations and he is doing a credible job at that huge task. Most recently Deutsche raised fresh equity capital to stabilize its balance sheet. This business retains amazing relationships and it owns some incredible assets. The shares of this formidable global bank were acquired at around 40% of book value – in comparison Commonwealth Bank of Australia trades at a share price around 250% of its book value. Now that the capital cushion protecting the business from insolvency has been strengthened this global bank will re-rate quickly once investors become comfortable it has stabilized.
TPG Telecom: 6% of the fund owns part of the Australian telecoms company TPG Telecom. Shares were acquired after TPG launched an aggressive expansion into Singapore which resulted in investors selling shares so quickly that the value of the company halved in 12 months. TPG acquired good assets in Singapore (undeveloped spectrum licenses) and the assets they retain in Australia are excellent (high profit margin with high barriers to entry). The Australian assets will allow them further scope to grow their domestic market share further, for example with well marketed NBN packages, while also comfortably funding the capital expenditure required to develop and commercialise their Singapore spectrum.
The portfolio has increased in value to $1.03792 per unit as at end March. Over the 64 days the fund has been operating that translates into 20.97% annualized rate of return.
If you recall our key objective is to deliver the best compounding rate on the fund’s capital. However I need to point out that quarterly results will not always be this good because market prices, including the price for shares in the companies we own, bounce around in line with investor sentiment.
The good news is that provided a company we own is growing in a sustainable fashion the share price will always eventually catch up to its increasing intrinsic value – I would like you to think of periods of mispricing when they come, and they will come, as either an opportunity for the fund to purchase more good assets on sale, or commonly witnessed market behavior we can ignore. The worst behavior for an investor is to buy good assets at good prices then capitulate and sell when the price falls.
Please remember all our investments are being made on a 5+ year horizons so very short term results can be expected to bounce around, up and down, over that time. You all know shares in great assets would not be selling at attractive prices if someone somewhere was not fretting about losing money and letting that fear make their decisions.
Leverage, derivatives and unlisted assets
The fund has not employed any leverage to date nor do I anticipate using leverage unless market prices fall substantially. No derivatives have been traded nor any unlisted assets acquired.
If anyone would like more information please reach out to: firstname.lastname@example.org