David Berkowitz of Riverpark is a fundamental value investor looking for attractive compound returns over multi-year holding periods. His first quarter 2018 letter just came out and discussed a few interesting holdings. The top 10 positions clearly reflect a valuation-based approach with a number of names that are also held by other gurus, like Carmax (CMX), Aercap Holdings NV (AER, Financial), Western Digital (WD, Financial) and Liberty Global (LBTYA, Financial), for example.
These are two interesting picks Berkowitz extensively discussed in his latest letter:
Carmax
Carmax (KMX) is in the business of selling used cars. It is famously held by Eddie Lampert who runs Sears, and did it very well for him. What does Berkowitz see?Ă‚
"Consistent with our investment strategy, the company has a durable business franchise, generates consistent free cash flow, is well managed, and trades at an attractive valuation.
KMX is able to deliver a superior customer experience and earn attractive returns by virtue of scale advantages. These scale advantages are numerous, including the ability to spread fixed costs across a larger base, hire and retain the best talent, and maintain the largest inventory, leading to greater selection."
I'll play advocate of the devil here and interject that Carmax may be well-positioned to retain the best talent, but does it really need to? And at what level? You could argue that talented customer-facing personnel could very well go out and start their own business in this highly fragmented industry. At a higher level Carmax may very well be able to attract the best talent, but smaller competitors won't have some of the overhead. However, large inventory is undeniably a big advantage. Carmax is a dionosaur in a fragmented market and Berkowitz believes this gets them a lot of data:
"Perhaps the least well understood, but most important scale advantage is market intelligence. In the last 12 months, KMX bought and sold more than one million used vehicles out of a nationwide market of more than 40 million, far more than any other car dealer. This dominant position provides insight into pricing, supply, and demand that allows KMX to bid more effectively for the cars it buys and efficiently price the cars it sells."
That's true.It gets the company a lot of data, but there are so many car sales platforms out there you could argue everybody has access to a lot of sales data. This advantage may not be as profound or strong as it once was before cars were sold over the internet.
"Its markets share is less than 5% in markets where it already operates and less than 3% nationwide, so these growth trends should continue well into the future. Skeptics of KMX have short-term concerns about the cyclicality of new car sales and longer term concerns about the sharing economy reducing car ownership, internet disruption of used car sales, threats from new car dealers, and used car price deflation."
I would add to this the threat of self-driving cars. Although I don't invest based on major trends that the market tends to price in, I do try to avoid industries that stand a fair chance of getting demolished. Self-driving tech is now really getting pretty close to a reality. It seems obvious that a self-driving future means we will utilize fleets of self-driving vehicles that suit our current need and pay-per-ride or have some kind of a subscription model. Fleets will be operated by specialized fleet operators.
Really, I'm one of the least prediction-prone investors I know, but this sort of future seems extremely likely. The bad thing for CarMax: There is no consumer-facing second hand business anymore. The video below lets you experience a self-driving ride in an Alphabet (GOOG) (GOOGL) vehicle:
"As a result, over the past three years, while earnings per share have grown by more than 40%, the share price has declined by more than 10%, compressing the forward earnings multiple from nearly 20 times to less than 12 times, a post-Global Financial Crisis low.
Based on our research, we believe the skeptics’ concerns are overblown and that KMX will continue to grow profitably for many years. Over the next two years, if KMX, which we believe is a significantly above average business and has historically commanded an above average earnings multiple, can achieve a market average multiple of 15 times, we will make nearly 17% per annum (even without any improvement to the current earnings multiple, we should earn over 11% per annum). If our earnings projections prove to be too conservative."
The share price is indeed down strongly year-to-date. But perhaps the market is pricing in the chance of complete disruption down the road?
Carmax is cheap on a fundamental basis. Its historical growth rate and solid capital allocation choices look extremely interesting. My main fear would be a self-driving future. It's not here yet and perhaps it will remain a mirage. I'm fairly certain that if a self-driving future doesn't materialize in the next 10 years, this will turn out to be a great investment.
Macquarie Infrastructure (MIC, Financial)
Macquarie Infrastructure owns and operates infrastructure businesses like storage tanks, power generation and aviation airports. It declined pretty hard this year:
Berkowitz likes management:
"We have generally found management to be thoughtful about their business and shareholder oriented. The largest of MIC’s business units, representing approximately 45% of operating cash flow, is International-Matex Tank Terminals (IMTT), which provides bulk liquid storage for petroleum and other products at marine terminals in the US. This business has historically operated at 93-95% occupancy rates, achieved low single digit organic growth in revenues, and with modest operating leverage, midsingle digit growth in operating income."
And Macquarie Infrastructure's new, (more) durable strategy:
"Our experience analyzing IMTT and competitors’ marine terminal businesses supported our belief that IMTT is a durable business.Our conclusion is that while IMTT’s marine storage business remains durable, it may have been overearning for the past few years, as MIC management chose to maximize near-term cash flow from a market with poor fundamentals (resid) rather than proactively and incrementally investing to mitigate exposure to this market. While we cannot be sure, we believe that the change in CEOs was the catalyst for the recognition that this strategy needed to change. The capital that MIC plans to spend to reposition certain assets should deliver high returns as it is far less costly than new construction and will not require an often cumbersome permitting process. At the conclusion of the repositioning, IMTT should have improved diversification of products and customers resulting in higher and more stable cash flows. Our experience in similar situations indicates that new management will likely be very conservative in its guidance at the outset of the strategic reset in order to re-establish credibility with investors. With this in mind, we believe new management has set the bar at a level that can likely be met or exceeded."
I emphasized a part above that mirrors my own experience, meaning management guidance is likely towards the low end of the range.
"Our view of MIC’s businesses and management has understandably been shaken by the experience of owning the stock through this process, but we feel strongly that at its current valuation, MIC is a strong buying opportunity. With the stock at $39 per share, the equity free cash flow yield is 14.5% and the dividend yield is 10.2%. From this new base, the company should be able to grow and continue to invest capital at attractive rates of return with potential upside from a sale of some or all of the company. With all of this in mind, we’ve recently been adding to our position and look forward to updating you in the future."
A free cash flow yield of 14.5% and a dividend yield of 10.2% is very impressive. I like this thesis where hard, infrastructure-like assets can be acquired at this type of valuation, and the idea deserved to be highlighted. You'll find more color and additional ideas in the original letter, which is highly recommended.
Disclosure: No positions.
