Klarman's Top Buys for the 3rd Quarter

The guru added 4 stocks to his portfolio

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Nov 15, 2017
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Seth Klarman (Trades, Portfolio)’s Baupost Group did not make many portfolio changes during the third quarter, but the positions added were, as always, interesting.

According to the fund’s latest 13F filed with the SEC, Klarman added five positions to the portfolio during the quarter. One of the these, however, was a special purpose acquisition vehicle that was renamed following an acquisition.

The warrants of The Simply Good Foods Co. (SMPL, Financial), which was formerly known as Conyers Park Acquisition Corp., appeared in the portfolio this quarter, but this is an old position. Conyers Park merged with Atkins Nutritionals Inc. to form Simply Good Foods with an enterprise value of around $850 million.

Simply Good only accounts for around 0.03% of Klarman's portfolio. The next most substantial addition is a holding in Pioneer Natural Resources Co. (PXD, Financial), followed by AmerisourceBergen Corp. (ABC, Financial). Combined, these two positions account for only 0.25% of Baupost’s equity portfolio.

The last two buys were the largest: AMC Entertainment Holdings Inc. (AMC, Financial) and McKesson Corp. (MCK, Financial). Together, these account for 1.62% of the portfolio.

So what’s to like about these two companies?

AMC Entertainment is a cinema business. It operates 10,000 screens globally, including over 661 theaters with approximately 8,200 screens in the United States and over 244 theaters with nearly 2,200 screens in Europe. The company also sells all the usual movie theater paraphernalia such as snacks and drinks.

Until the middle of 2017, AMC was booming. Over the five years leading up to 2016, revenue rose from $2.5 billion to $3.2 billion and operating profit expanded at a compound annual growth rate (CAGR) of 17% thanks to improving margins.

This year, the company has been walloped by a mediocre movie slate, which has slammed earnings and profits a year after the company splashed out buying Odeon and Nordic, more than doubling net debt.

There is a more significant issue here, however; and it seems to be the reason the stock has been cut in half over the past six months. Even though trading is slow, it seems investors are more concerned about AMC Entertainment’s parent, Dalian Wanda (HKSE:03699, Financial), which is facing scrutiny from Chinese policymakers regarding its overseas deal spree. As the New York Times explained in July:

“Shares in AMC dropped 10 percent on Monday after a mysterious document on social media claimed that regulators in China were warning state-run banks against financing Wanda’s deals overseas. The credit ratings agency Standard & Poor’s put the Chinese parent company on negative credit watch on Monday.”

It appears Klarman is betting this will only be a short-term headwind to the stock price. It seems management agrees as they recently celebrated the buying back of “$30 million of AMC common shares at historically low prices.”

Like AMC, McKesson has also seen its share price cut in half since the highs of 2015. Recently, the company has come under pressure due to concerns about the U.S. health care system, how it will change and who will be forced out of business as reforms are introduced.

There is also an ongoing investigation concerning how the company benefits from higher drug prices. The 45 states that recently made sweeping allegations of price-fixing against 18 generic pharmaceutical companies want to probe further to understand how wholesalers benefit from higher drug prices.

Klarman may believe these issues will only be short-term headwinds. If they do dissipate and the company gets back on track, this could be a great opportunity. McKesson has been able to grow net profit at a CAGR of 29% for the past six years and currently trades at an EV/EBITDA ratio of 4.9. Return on capital employed hit 25% last year.

Disclosure: The author owns no stocks mentioned.