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Monthly Report International Fund June 2022


“Predicting rain doesn’t count; building arks does.”

You might question our right to open with a Warren Buffett quote after the year we’ve just had. Giving back more than half the outperformance of 2020/21 in an increasingly difficult market environment, the exact time when value investors are supposed to shine relatively. It’s all for the purpose of selfflagellation.

Buffett used the so-called Noah rule to castigate his own performance after his insurance business was walloped by the September 11 terrorist attacks. He didn’t lean on “unknown unknowns”, “perfect storm” or the musician Shaggy’s “It wasn’t me” defence to describe the left-field event. He focused on how he should have been positioned in such a way that would have made Berkshire Hathaway more resilient to any such calamity.

We know the feeling. Yes, smaller capitalisation stocks got hit particularly hard this past year, with the World Small Cap index down 23% over the past year. The index now trades at a price to- earnings ratio not seen since the global financial crisis back in 2008. Technology and faster-growing businesses more generally were hit hard, with the Nasdaq down 30% these past six months alone. The number of Russell 3000 (non-financial) companies trading for less than cash has surpassed the month-end record set during the Global Financial Crisis. Finally, the compression of valuations for global markets—measured by the ratios of price to trailing earnings for global stocks—has been the greatest since the stagflation of 1975.

It has been a calamitous year, particularly at the smaller end of the market where we tend to invest.

The whole point of having a wide and flexible mandate, though, is so that valuation discipline can be exercised in heady times.

The team spent a lot of time over the past 18 months discussing the outlook for rain. We talked about the similarities with the 1999/2000 tech bubble and the inflation/stagflation of the 1970s. And made some meaningful shifts in the right direction. You could call that half an ark—one that didn’t float as well as it is meant to.

Long-term winners giving back the gains

Let’s start with a group of stocks where the original investment thesis is largely on track. Here, share prices have given back some, all of or more than the enormous gains from 2021. But the business is largely on track versus expectations at the time of purchase.

Ammunition manufacturer and user gun broker Ammo (NASDAQ:POWW) returned to earth after a massive run-up in price 12 months ago. Nearly half the investment was sold last year, but not quickly enough to avoid the 2.8% hit to portfolio returns, our worst performer of the year. This is despite the share price only being down 20% since our major purchases in 2021. The market holds concerns centred around profitability and cash flow. We share some of these concerns. But the online brokerage business is going strong and Ammo’s new production facility in Wisconsin is set to open later this year, which will allow them to double production volumes on the ammunition side. The Fund maintains a 2.1% position—should everything go smoothly there is tremendous upside in the share price.

Fathom Holdings (NASDAQ:FTHM) is a small-cap company that is disrupting the online real estate industry in the United States. It was one of the Fund’s top performers last year and we sold heavily more than 12 months ago. The company continues to do very well operationally, with sales growth over recent quarters exceeding 80%. However, given its exposure to the housing sector and its smaller size, the derating has been extreme, reducing returns by 2.1% in the process. The investment has been increased again during the past six months but it remains modest in line with the risk involved.

Used car retailer Motorpoint (LSE:MOTR) disappointed the market with a subdued profit outlook for 2023, despite continued rapid sales growth. It reduced Fund performance by 1.8%. Traditional competitors have used inventory tightness to earn record gross margin per sale for a second year running while volumes stagnate or fall. Motorpoint has played its cards very differently, proactively reducing gross margin to help grow volume by 46% over the year. We think these market share gains will have longevity after the margins normalise. The other issue has been some deep-pocketed new online-only competitors like Cazoo. With Cazoo’s share price down 93% over the past year and making cuts everywhere, that threat is likely waning rather than growing. Motorpoint’s response has been to maintain the elevated marketing spend of recent years, well above pre-COVID spending, and take the fight to the newcomers. We think that’s the right call long-term despite the margin pressure it brings for now.

Fintech company Open Lending (NASDAQ: LPRO) has been delivering very solid operational performance despite facing numerous headwinds including a lack of used and new cars for sale and car manufacturer shutdowns. In this environment, smaller stocks exposed to discretionary spending are being punished. Despite continuing to grow earnings impressively, the stock has de-rated by over 50% since we bought it and now trades on a sub 10 times earnings multiple. It detracted 2.3% from returns this year.

Thesis off track

In contrast to the above, we can’t claim the below were just good ideas caught up in a difficult market. The next seven stocks haven’t produced the results to justify our original thesis. Overall, we made good money on a few of them. But they all lost us money this past year. While they remain on watchlists and might be attractive again at heavily discounted prices, most have been sold for now.

Whole Earth (NASDAQ:FREE) makes products with very stable demand (artificial and natural sweeteners). Unshackled from a heavily indebted major shareholder a few years ago, the thesis was that running costs and marketing spend could be optimised in a way not possible beforehand. It’s a playbook we’ve seen many times before. Instead, we’ve seen profitability eroded, largely due to a large acquisition that has underperformed and burdened the company with significant debt. Whole Earth crimped Fund returns by 2.5%. We sold the bulk of our position over the course of 2022 and will likely be out of the stock soon.

iLottery software company Neogames (NASDAQ:NGMS) is a business that we expect will continue to grow and prosper. But picking up new state contracts has been slower than expected. And the deal to acquire former parent company Aspire, with its suite of B2B iGaming solutions, muddied the waters and dilutes the exposure to iLotteries. We’d been selling down for more than 12 months but should have moved more aggressively. The Fund made money out of the investment due to sales at much higher prices, but in 2022 it cost 1.8% of performance.

Same for PLBY Group (NASDAQ:PLBY), one of our best performers in 2021. While we had sold heavily before the worst of the downturn and made very good money overall, the remainder detracted 1.1% from Fund returns this year before the investment was entirely liquidated. It was yet another stock where a recent high-priced acquisition added to its woes and slightly detracted from our initial thesis. We continue to see value in the brand name and the longer term story here and we may revisit the investment in the future.

We bought online retailer boohoo (AIM:BOO) in 2020 after the stock had fallen in response to perceived growing pains. Over the first half of 2021/22, the stock fell sharply. By the pre-Christmas trading update, we recognised that the market had been right and we were wrong. Some of the issues, such as high return rates, were more structural than cyclical. Before losses were cut, boohoo detracted 1.5% from Fund returns. It could have been worse—the stock has more than halved again since the last sale.

BM Technologies (NASDAQ:BMTX) is a quirky small-cap that operationally delivered to expectations and now trades on nine times earnings. However, the company is about to lose one of its main sources of revenue, parting ways with its old banking partner at the end of 2022. The company acquired a small bank as a replacement but the situation is getting complicated and the range of outcomes has widened substantially. The stock reduced overall returns by 1.3%.

Twitter (NYSE:TWTR) is another busted thesis. While the business has immense potential, it has a long track record of falling short. Elon Musk tried to bail us out with a cash bid at $54.20, and we reduced exposure on-market after the announcement. But he’s spent the past few months trash-talking Twitter, presumably to help him either recut or walk away from the deal. That explains why the stock trades at a whopping 31% discount to the bid price. Our Twitter investment reduced returns by 1.4% this year.

Pinterest (NYSE:PINS) was a similar story although, in contrast to Twitter, we only caught the downswing and not the upswing that preceded it. It was a clear beneficiary of the covid lockdowns. A year ago, financials hinted that underlying growth might overwhelm COVID unwind. The stock fell dramatically when it became clear that this would not be the case and clipped returns by 1.9%. We don’t own Pinterest today but may again at some point. Despite the recent disappointment, the company holds a lot of potential.

Defensives unhelpful

Our growth bubble concerns led us to focus fresher purchases on established businesses trading at low multiples of earnings. Some large, some small. We’ll know in a few years which worked and which didn’t. But none helped out this year the way we’d hoped.

Meta Platforms (NASDAQ:META), née Facebook, is the biggest misstep here. In part, we invested in the stock because we were predicting rain and trying to build arks. Instead, the stock almost halved over the second half of the financial year, with much of the damage done on a single day in February. It cost the Fund 2.2% of performance. There are legitimate market concerns, such as Chinese competitor TikTok and whether the company will blow its prodigious cash flows in an all-in bet on the metaverse. We don’t have definitive answers but management has stressed its focus on profitability and tapered back investments on some of its other bets already—a positive sign.

If you told us a few years ago that this still-growing business would be trading at less than 13x times expected earnings, we’d have struggled believing you. Even if a few things continue going wrong the stock is very attractively priced.

We bought into RumbleON (NASDAQ:RMBL), an online powersports distributor via a capital raise as it completed a merger with RideNow, the largest bricks & mortar distributor in the United States. The deal offered a number of synergies and was well received by the market. Due to this, the stock held up well until the fourth quarter of the year, where it joined the pity party due to the heavy selloff in consumer discretionary businesses. The stock clipped Fund returns by 1.1% over the year and now trades at about five times 2022 expected earnings.

Turning Point Brands (NASDAQ:TPB), the manufacturer of Zig-Zag rolling paper and Stoker chewing tobacco, continues to grow well. However, it has also de-rated significantly like most other smaller stocks in the US, lowering Fund returns by 1.1%. We feel the business is underpriced given the growth prospects of its core businesses. While a much bigger and broader business, the bid for Swedish Match by Philip Morris hints at the potential for corporate action in the sector.

Any business with exposure to advertising has seen its share price hammered, irrespective of results or cheap starting valuation.

Tremor (AIM:TRMR) offers software platforms enabling advertisers to reach audiences, with a particular niche in connected television. It’s growing rapidly and is cheap versus earnings. It reduced Fund results by 1.4%. It’s a small position and we’re waiting for more evidence before adding or cutting  and running.

Zeta Global (NYSE:ZETA) provides businesses with consumer intelligence and marketing automation software. It bucked the selloff trend for the first three quarters of the year, before collapsing in the last quarter despite a good result and increased expectations for this year. The long-term story still looks attractive. Overall, it clipped 1.0% from returns.

In addition to cheap defensive stocks that unfortunately got cheaper, we did buy one new growth stock fairly recently. Too impatiently, mind you, clipping 1.1% from Fund returns this year. But the thesis is still on track. Cryoport (NASDAQ:CYRX) transports biological products around the world at super chilled temperatures, where margin for error is miniscule. It has a wide and growing moat and is an essential partner to the rapidly growing life sciences industry. But we kept adding as the stock fell dramatically. It seems to have found a floor, with the share price rising more than 50% from its May low by 30 June. Cryoport is one of the Fund’s top five investments.

Things that worked

In a mirror reverse to last year’s result, no one stock provided a positive 1.0% contribution to overall return. The handful of positive contributors included energy drinks company Celsius Holdings (NASDAQ:CELH), a business we’ve traded in and out of deftly. It was the biggest positive contributor in 2020/21 and one of the biggest the year prior. It also jumped the low bar of top performers in 2021/22, no mean feat in a year where the share prices of most small companies were hammered. Other positive contributions came from Norwegian manufacturer Norbit (OB:NORBT) and Vienna Airport owner Flughafen Wien (WBAG:FLU).

Early in the financial year we acquired a small basket of commodity-related names, mainly as a hedge against inflation. The overall position was small but the basket added 0.5% to Fund returns, helped particularly by the tripling in share price of US coal miner Alpha Metallurgical Resources (NYSE:AMR).

When financial results matter

As noted in the CIO letter to this performance report, wild swings in momentum and over-reactions in both directions seem to be a recurrent feature of modern financial markets. We clearly need to do a better job of navigating those waves—likely making less on the upside and drawing down less on the downside. Ultimately, though, we remain focused on buying businesses at attractive prices and participating in that value realisation over time.

While there have been missteps, the strike rate has been more than satisfactory over the history of the Fund, particularly the three years this investment team has been together. Today, there are more companies trading at attractive valuations than we have seen for a long time. That should portend well for the future.