The ACE Fund unit price rose 1.2% in August, bringing the total return since inception on March 31st, 2014 to 6.4% after all fees. This is consistent with our stated objective of delivering positive absolute returns with low volatility.
August was an exciting month for us, as there were several material events within the portfolio. Specifically, we had the positive rebound of Essential Energy Services (ESN-T, www.essentialenergy.ca), a company that was highlighted last month as having fallen to an excessively deep discount versus our estimate of value. Apparently the market agreed with our assessment and the stock gained 19.2% during the month. The Fund also benefited from our newest US position, Green Plains Renewable Energy (GPRE-US, www.gpreinc.com), a producer of ethanol and biofuels that gained 18.6% on the month. These gains were offset by Canam Group (CAM-T, www.groupecanam.com/en), which lost 14.5% in August after a quarterly earnings report that disappointed the market.
Recall that when shares of Essential Energy swiftly dropped 17% in July we were happy buyers of the stock and we view the current correction in Canam shares as an equally attractive opportunity to add to our position. With this pullback, Canam is trading at a significant discount to both its own historical valuation as well as its peers. In fact, we find the value in Canam shares so compelling that it has become the Fund’s largest position (5.3% weight).
We believe that Canam has a very visible runway for growth and is in an excellent competitive position within their steel joist and bridge building business. We believe that the current share price represents an excellent entry point for this solid Canadian company given the current strength in non-residential construction (as per the Architecture Billing Index; below, left) and the tremendous growth in Canam’s backlog over the past 2 quarters (below, right).
Our analysis suggests that the composition of the company’s shareholder base is presently undergoing a substantial shift. Short term investors have headed for the exits, creating opportunity for long term holders like the ACE Fund who are focusing on the company’s future cash flow generation. The trigger for this flight of investors has been the company’s failure to meet earnings expectations during the last two quarters. We recognize the potential for some short term pressures (i.e. hiring new people to tackle the backlog) but these are directly related to the company’s record high pipeline. Owning a piece of Canam today allows us to participate in the growth of this company’s cash flows, which we believe will increase significantly over the next couple of years. Additionally, we expect the market to increase the multiple at which it values Canam as the company grows in scale, scope and capabilities. To give you a sense of the projects Canam is currently winning, it was recently awarded contracts to provide steel components for the replacement of both the Tappen Zee and Goethals bridges in greater New York City. These are long (>4 years), high profile projects that were awarded at a time when the company’s backlog was already at record highs.
An old adage about stocks suggests that “when groceries go on sale, people load up, but when stocks go on sale people run away” This saying highlights a interesting element of investor psychology and one that provides valuable insight into our methodology. Another way of looking at this type of behavior would be to ask yourself whether you prefer to invest “with the grain” or “against it.” The answer, for us at least, is “it depends”.
Investing With The Grain
Supply and demand plays an important role in the discovery process for stock prices. We believe that improving operating performance, an interested and enthusiastic stock market following, and a positive technical outlook are all characteristics that increase demand for a company’s shares, thus encouraging their price to rise. Most of the time when we make an investment it is because we have identified an undervalued company for which all of the above criteria apply. So at our core, one could say that we are “with the grain” investors.
Investing Against The Grain
When a company’s share price declines sharply it can be for any number of reasons: a material deterioration in business fundamentals, a negative shift in sentiment, a big holder needing to liquidate, or some combination of these and other factors. The most important thing for us in this situation is to determine if we were wrong in our original estimation of value, or if our original estimate should be negatively revised in light of new information. Our desire to preserve capital is strong and in many instances our original thesis may miss the mark. If we believe this to be the case, then we will become sellers and look for better opportunities elsewhere with our capital. However there may be certain instances where we feel that we have a very deep understanding of a company’s business and assets, and are extremely confident that our estimation of its value is accurate. It is at these times that we will energetically invest “against the grain”.
What determines whether we invest with the grain or against it in each case is where the company’s stock price is relative to our estimate of its value. As value investors, we view companies as assets which possess an intrinsic worth or value that is derived from its ability to generate cash for its owner. Successful value investing requires holding a strong conviction that our assessment of value is correct and concentrating our capital in those assets for which our conviction is highest. This is how we viewed Essential Energy Services in July and how we view Canam Group presently. These are just two of the non-consensus investment ideas which we believe will contribute superior, positive and uncorrelated returns to the Fund over a moderate holding period.
Our discipline is designed to help us find companies whose share prices represent the highly attractive investment opportunities over the next 6-12 months and then acquire shares so long as price is attractive compared to (a) our estimate of value and (b) other opportunities in our universe. Our process allows us to build a deep fundamental understanding of portfolio companies and gives us the conviction to both invest with the grain as well as “stock up” if the products we like go “on sale”.