2017 FUND YEAR-IN REVIEW
Originally Posted January 16th, 2018: https://woodworthfund.blogspot.com/2018/01/2017-fund-year-in-review.html (Some links below may be broken)
Feel free to contact us at our office during the week between 6:30 AM and 2:30 pm PST at 1-800-651-1996. SEE OUR DISCLAIMERS AND DISCLOSURES BEFORE READING HERE.
At the time of writing this, statements for the December 2017 value of investments into the fund are being sent out. We wanted to take this opportunity to give everyone a general update on the status of the fund and where we believe things may be headed into the new year, and happily report that the fund has attained new all-time highs as our positions taken earlier in the year have begun to bear fruit. Overall, the fund net asset value under management has risen by over 5% on the year which, though underperforming in comparison to the general market on the calendar year, has actually outperformed four of the last five months in comparison to market benchmarks as a fully invested fund. It is an unfortunate fact that the launch of the fund at the beginning of the year, and subsequent three-month period which it took to get fully invested, had a significant effect on performance at the beginning of the year when the averages made the bulk of their gains. As a reminder, we also have ~5% of the fund currently invested in a series seed round of funding, meaning that the company does not trade and, as such, we are relying on a book valuation for that portion of the fund which does not float like the other 95%, which effects performance slightly in the short-term until the value can be adjusted.
RETAIL AND RESOURCE GROWTH STOCKS PAY OFF
As many of you remember from our conversations earlier in the year, we had pushed to weight the growth portfolio portion of the fund more heavily into retail in the first half in the year, taking advantage of the animosity towards brick-and-mortar retailers. Currently the growth portfolio is the largest portion (~50%) of our portfolio.
As the economy continues to grind higher and higher, many of the natural beneficiaries have been natural resource companies specializing in the exploration, mining, production, and processing of minerals. In particular, we had invested the fund into several stocks which have benefitted from this move, including Smart Sand Inc. (NASDAQ: SND), an industrial sand manufacturer (sands primarily used in fracking and the oil and gas industry) based out of Texas, Noble Corporation plc (NYSE: NE), an offshore drilling contractor based in the UK, and in particular we would highlight Freeport-McMoRan Inc. (NYSE: FCX), a mining company based out of Arizona with a focus in Copper mining which has done exceptionally well (gains are currently sitting around +55%). We believe that Cramer with Mad Money actually recently referred to Freeport, saying it was “Not in the playbook”. As usual, the fund has focused in companies which, though their sector has been out of favor, the individual company sits on a solid financial base from which it can glean the most benefit from any rebound in the sector. We believe that we still have much further to go in these stocks.
All that glitters is not oil and copper, though, and we would highlight our investment into Eldorado Gold Corp (NYSE: EGO). The position is currently one of our larger underperformers at this time (total performance for the stock is around -50%). The fund continues to hold this position as we see nothing fundamentally wrong with the company. The move to the downside in Eldorado appears to be largely attributable, as with many other commodity-linked stocks, to the underlying price of gold which is still trading far below its 2011-12 highs near 1800 per ounce (currently gold trades at just over 1300 per ounce). Of course if we had wanted to purchase gold to purchase gold we would have bought into any of the numerous gold ETFs or even gold futures. No, the primary reason for the fund’s stake into Eldorado is more due to the undervalued and next to zero debt load of the company, combined with the fact that the Canadian company owns some of the most profitable gold mines on Earth (though they have had labor and political issues with their mine in Greece). We believe that Eldorado is a good investment primarily because the company has been unfairly beat up by a market primarily focused on the price of the company’s commodity, and not the company itself. In fact we have actually increased our stake in the company with the recent downward pressure, believing that the combined downward pressure of gold and their Greek mine’s political issues has presented a buying opportunity in the stock. This stock has, of course, effected the portfolio, but we strongly believe that this stock is vastly undervalued when taking a longer-range view. Our investment into Cameco Corp (NYSE: CCJ), which is the world’s largest publicly traded uranium company based out of Canada, has similarly underperformed since we purchased it in July, though not quite to the same degree. Like Eldorado, Cameco has been heavily influenced by the whims of the uranium commodity markets, and has also been especially effected by ETFs and other funds focusing on uranium, as there are so few uranium-focused stocks out there to trade which concentrates them in the stock. Given the finances of this company we believe it to be similarly undervalued in the long run, and that the death of nuclear energy has been greatly exaggerated with the resurgence of the global economy.
The pivot which has dominated the fund over the course of the last year though, of course, has been the fund’s heavier weighting into retail. In particular, we would highlight one of our largest gains for the year, Lumber Liquidators Holdings Inc. (NYSE: LL). This particular stock was originally purchased for $16.58, and half of the shares were later sold for ~$34.84 into short covering and stronger earnings, for a return of +111% on those shares. Lumber Liquidators had long been the subject of litigation involving the sourcing of some of their wood, which though it had wrapped up by the time we moved into the stock, still cast a shadow over the stock as the company sat near its all-time lows despite being in decent financial health. Though we believe in the long term future of this company, we have since dropped down to half of our original position in the stock to de-risk the portfolio somewhat and mitigate volatility produced by the larger position. We believe that our investment into Tile Shop Holdings Inc. (NASDAQ: TTS), is in a similar position and could outperform in the long-run as well. Our positions in retailers such as Vera Bradley, Inc. (NASDAQ: VRA), and Francesca’s Holdings Corp (NASDAQ: FRAN) have not turned yet, but from our own analysis of these companies we would not be surprised when they do. We have also taken gains in companies such as Tractor Supply Company (NASDAQ: TSCO) and Restoration Hardware (NYSE: RH).
Other investments of note for the quarter include positions we have taken in such stocks as Avid Technology, Inc. (NASDAQ: AVID), a multimedia company based in Massachusetts. This particular company was left for dead with the transition of video software from a small, closed (and expensive) elite group to a more broad-based market. Despite all this, the company remains in great shape and a leader in the industry, and over the last year have transitioned into the new software at the cost of a lot of short-term pain.
MIXED DIVIDENDS
Our dividend portfolio, which currently makes up ~30% of our total fund, is naturally the most risk-off portion of the fund, and contains stocks which we would consider to be more conservative investments, though by maintaining our philosophy of contrarian value investments we have been able to maximize the yield of this portion of the fund. The current yield on this side of the fund, not accounting for any capital gains, sits at a healthy 5.15%. This helps to supplement our fund cash reserves to cover fund expenses, such as research, management fees, and distributions, which stabilizes our portfolio. On occasion we will reposition this portfolio to take advantage of equity gains or rebalance the portfolio, but primarily the expectation with this portion of the fund is that no news is good news. While the dividend portfolio can contribute to underperformance due to its conservative nature, it also serves to help anchor and diversify our holdings.
Of course, with higher dividend yields comes the risk that companies may cut it to save money. This is exactly what occurred in Black Box Corporation (NASDAQ: BBOX), which cut the dividend in September of last year. The fund has since sold out of the position as Black Box has continued its decline. Funds were used to move into Qualcomm, Inc. (NASDAQ: QCOM), which was subsequently sold at a significant profit when it was announced the Broadcom had offered to buy the company in what would have been the largest technology acquisition ever ($103 billion total offer at $70 per share). The bid was recently rejected by Qualcomm, but the fund no longer holds a position in that stock.
We would also highlight our investment into Kohl’s Corporation (NYSE: KSS), which recently went long-term (eligible for a lower tax rate on capital gains) on January 12th. This particular stock was purchased towards the beginning of the fund, has variously been at an unrealized loss as high as -14% over the course of 2017, and more recently had unrealized gains of over 55%, with plenty of volatility in between. All the while, the stock has kept a consistent dividend, adding another 6% in total yield. We expect that the blame for this volatility mostly rests on last year’s perception of retail as a riskier category, despite Kohl’s solid track record and financials. As of today, January 16th, we have taken our long-term capital gains and exited this position to replace Kohl’s as the increase in value has resulted in a decreasing current yield for that position. As we produce capital gains in our dividend stocks, We expect to regularly rotate out them into positions with higher yields, such as we had already done with companies such as HollyFrontier Corporation (NYSE: HFC) and Domtar Corporation (NYSE: UFS), which we believe got ahead of themselves in valuation.
SHORT POSITIONS
A minority of our fund (<10%) has been dedicated to short positions, meaning that the fund has borrowed stock from an institution and sold it for cash in the expectation that the stock will lose value in the future. This allows the fund to repurchase the stock at a lower cost, generating a profit off a bearish move in the market. Generally the short position that the fund takes will be smaller (roughly half-sized) due to the theoretical increased risk that a short position entails.
As the fund is contrarian, we have naturally sought out larger-name stocks which have benefitted from the recent trend towards momentum-based investing. The exact market exposure of these names vary from established online retail giants such as Amazon.com (NASDAQ: AMZN), to the relative newcomers to the market such as Elon Musk’s Tesla (NASDAQ: TSLA). We have also previously taken gains in our short positions in iRobot Corporation (NASDAQ: IRBT), Wayfair Inc. (NYSE: W), and Century Aluminum Co (NASDAQ: CENX). The exact reasoning behind these positions vary, but in any case it is a simple value-based calculation that the expectations priced into the stock of the company has gotten ahead of its actual real-world growth, and we would expect to cover these shorts (buy the stock back at a profit) in the event of a pull-back rather than hold the short in the expectation of bankruptcy, which would be a far riskier proposition. In such a way we expect to minimize our potential risk.
As an added bonus, the particular stocks we have chosen tend to be those popularly held in retail (individual) portfolios and funds, meaning that in the event of a general market pull-back, the downward movement of these stocks will help buoy our portfolio to the upside against a down market. The popular (and in my opinion, overhyped) nature of these stocks also keeps short interest costs of borrowing the stock to a minimum. In particular, we have made the fund money shorting Amazon several times in the past, taking advantage of shorter-term pullbacks in the stock. The recent run up has hurt our short positions, but we think that in the longer term this has caused some stock valuations to rush ahead of themselves.
PRIVATE EQUITY AND SECONDARY ROUNDS OF FUNDING
The fund, as an accredited investor itself, has access to markets which normally would have taken too much extra time and compliance cost to be worthwhile to invest in when Drew was a broker. These positions are naturally the most speculative positions that we are willing to take as a liquid fund, but they also carry the highest potential for returns in the portfolio. As such, the exposure that the fund has to these positions may vary greatly according to their performance, but we aim to keep the fund’s exposure to these positions at less than 10% of our net asset value. These also include investments which will be held in a so-called illiquid “side-pocket” investment until such time that they become free-trading and are able to be properly valued.
Though we do not intend to move the fund too heavily into such markets, earlier this year we had taken a position in a late funding-stage California-based biotech company Biotricity, Inc. (OTC: BTCY). This company patented and has just recently gotten FDA-approval for a multi-point home heart monitor, which they plan to lease out for doctors to use with their patients. For our first foray into such markets, the fund has come away from the deal exceptionally well. Our deal into BTCY was struck at $1.75 with warrants to purchase half the number of shares at $3.00 anytime in the three years following the close of the deal (2020). This stock was restricted from trading until it could be delivered into a brokerage account, meaning that in your statements it would have included this position at a 35% discount to what it was actually trading at. Luckily, BTCY became free trading as of the end of December. This stock last closed at $7.59, a valuation which netted the fund a whopping +334% return in the common stock position alone from the time of purchase in April. Taking into account the unexercised warrants the total return on the deal is an even larger +466%, more than centupling the money used in the deal. The stock has come off somewhat since then (As of writing sit at a total return of about +300%), but we do plan on selling out at least part of the position at the right time to lock in the gains at a reasonable profit and to de-risk the portfolio somewhat, and may still hold some of the stock longer-term depending on how their sales shake out. Warrants came with the deal at no cost, so there is a potential that we may hold those as well while we wait for more developments at the company. Going forward we will be considering this stock, as long as it is held and fully tradeable, as a part of our Growth Portfolio.
Given our success with Biotricity, we have additionally moved forward with another private investment which is close to up-listing, a company by the name of Ammo, Inc. (OTC: POWW) which manufactures specialty tracer bullets. We personally believe that this company is a good fit for us as firearm and ammunition related stocks have come off following the last elections of a government perceived to be looser on gun regulation. The company has already begun manufacturing, and we actually have a carton of 9mm samples on our desks as of writing. The bullets are manufactured with patented illumination technology as opposed to catching fire, causing them to be visible to the individual firing the bullet but not the intended target, giving them an advantage over traditional tracer bullets which can give away the position of the operator. This utility is expected to be of value to government contractors. This stock will be restricted from trading for the next six months, and the value of this investment will be discounted at a rate of 35% in statements for this period of time much as Biotricity used to be. The purchase price of the deal was at $1.65 per share of common stock with half the number of shares in warrants tacked on exercisable at $2. Pleasantly, the stock has already begun creeping up over the past few days with a closing price last month at $3.15 (restricted total return of +85%), and more recently trading at levels in the range of $3.70 (restricted total return of +104%).
Our final private investment, and the least liquid of the three as it does not trade on any public exchanges yet, is into the Volta Powergen Corporation. This was a Series Seed investment made by the fund into the local Oregon company in exchange for a 22.5% share of the company in preferred stock. The company manufactures a superior type of biogas (otherwise known as collected landfill gas or cattle flatulence) engine at a lower cost than any currently available in the market, though the engine also runs well on regular natural gas and aviation gas, and has generated significant interests in those market as well. We are happy to report that the company has completed its testing of the engine technology and has a fully-functional, fully-patented proof-of-concept engine. We have been heavily involved as a fund in organizing the Volta Powergen CEO and helping the company get to a stage where their product is marketable, and we are pleased to say that our efforts have paid off. The company has come in greatly under-budget and is now pursuing its first sale, which will not require any additional funding on the part of either the fund or the use of debt. We have to say that we did not expect that visiting a cattle farm to inspect an engine that runs on cow farts would be part of my job description managing the fund, but we have found the entire experience to be immensely enjoyable. Assuming sales operations go well in the next few months we also expect the exercise to be extremely profitable as well. In the short-term, there have been talks of announcing a dividend on the preferred shares held by the fund once the company has generated some cash flow to give the fund some return on its investment as long as we are locked into the company. In the long-term, and should the company maintain momentum and pick up a larger number of orders, we expect to eventually help take a portion of this company to the public market (~10-15%) out of the founder’s shares (as opposed to ours). Even further down the road, there could be the option to sell to a larger company such as Caterpillar assuming the company becomes more established in the industry. In the event that the company is taken partly public, we expect the investment to have appreciated significantly in value by that point. For that matter we expect that the valuation of the company will have appreciated significantly with their first order. For now however, this investment is valued at book (no change) in our accounting, and we expect to continue to update you as developments occur. For more up-to-date news, you can also follow their Facebook page, or check out their website.
LOOKING FORWARD
As a disclaimer, this email has contained forward-looking statements, which may or may not reflect what actually happens in the market. That being said, we expect to continue to take gains and pivot out of our heavier weighting into retail as our positions mature, but overall we would say that the economic outlook looks bright. Earnings continue to show strong growth across sectors, and we will try to ratchet down costs as we grow. This first year has been exciting, and we plan to send out these emails on fund performance more regularly going forward, now that we are more established. Expect us to also find areas to increase the efficiency of our capital use as we grow in size.
We would also like to take this opportunity to let you know that my younger brother, Quinn Millegan, has also begun taking on additional responsibility and ownership here at the fund. Expect to hear more from Quinn going forward in 2018. We consider his help and fresh perspective to be invaluable, especially as we expand. He is more technically inclined than, so we expect him to help drive efficiency gains in our workflow. Feel free to contact us at our office during the week between 6:30 AM and 2:30 pm PST at 1-800-651-1996.
