Magallanes Value Investors is a Spanish value investing asset manager founded in 2015. It was named after the historical Portuguese explorer Fernão de Magalhães, who was the first to circumnavigate the earth in an 1519 expedition completed by Juan Sebastián Elcano. It is also a tribute to the Magellan Fidelity Fund, managed by legendary value investor Peter Lynch.
Since inception (Jan. 29, 2015) its European Equity Fund registered an accumulated return of 15.36% versus 1.57% for its benchmark. 2018 was a though year with a performance of -18.78% versus -10.57% for the index.
Ivan Martin, the CIO of Magallanes, in his fourth-quarter letter to investors reminded that “stock market investments have to be for the long run” and that volatility also creates “opportunity.”
To give a sense of the conditions that recent market correction created, Martin presented their investment thesis for Renault, calling its current market capitalization “a financial aberration:"
“Renault’s share price has fallen from 100 to barely over 50 Euros at the end of the year, it has lost over 15 billion Euros in value in less than twelve months. Renault is an interesting case, because a number of adverse effects, internal and external alike concur simultaneously. The looming threat that electric vehicles represent, the singling out and persecution of internal combustion engines, increasingly popular car pools and shared-car programs and impending self-driving cars was not enough, now Renault has to take on, additionally, a strong exposure to emerging markets (Brazil, Russia), and, what's more, a top brass scandal with Carlos Ghosn, detained in Japan, awaiting trial and accused of financial misconduct after having understated his pay during the past few years. Nissan itself made this charge, Carlos Ghosn was Nissan’s chairman and Nissan’s board by all accounts approved his remuneration package.
In the face of a situation such as this, typically our animal spirits would egg us on to sell and forget. That was exactly what we felt like doing, but we decided, before taking any action, to revisit the investment case very closely. At the end of the day and after careful consideration, we decided not to sell, and it is in the valuation that we find the why and wherefore. The valuation, in fact, seems to us to be a financial aberration.
The market value of its stakes in Nissan (43.4%) and in Daimler (1.55%) is worth 14 billion Euros, but if we add a cash position of 3 billion euros – notwithstanding further amounts, like the book value of RCI Banque amounting to 4.3 billion and its Chinese JV worth 500 million – its total value is 17 billion. This is nearly 1 billion more Euros than its current market value. Which really makes no sense at all. In case we got the numbers mixed up, what with all the millions and billions we had to keep track of, and just to keep things simple, let’s just say that, with each and every Renault share we buy on the market today, comes “free of charge” the car manufacturing business (and that’s 3.5 million cars sold every year) as well as the financial services division RCI Banque.
Furthermore, should the traditional “sum of the parts” not convince us fully, we can look at the Renault case from the cash generation angle. Currently the company generates some 3 billion in free cash flow, a yield of almost 25%. We need to bear in mind that it has no debt, but rather net cash to the tune of 3 billion, and that it is listed at about 50% of its book value. Should a recession come about, with an ensuing drop in car sales, we might Magallanes Value Investors, reasonably assume a 50% drop in its cash generation, which in turn would translate in a 12.5% yield instead of 25%, which seems to us to be an attractive enough number.
Nevertheless, some skeptics might argue that the real problem lies in the financial services division, since the residual value of diesel cars may be much less in the future. There is a risk of that, true, but let’s again do the numbers. According to RCI Banque’s 2017 annual report, of the nearly 44 billion in assets, the risk of residual value is limited to 13% of the total assets, which would actually be reduced to 6.5% if we assume that one half corresponds to diesel cars (i.e., 2.8 billion at risk). The average maturity of these leasing contracts, according to the annual report, is of not quite two years. It would seem farfetched to think that, in this period of time, the value of second-hand diesel cars will actually be zero. Even if we were to assume a drop of 50% in value, instead of the expected residual value, the impact would be of some 1.4 billion euros, and this group will generate over 4 billion in profits this year.”
