Q1 ended on a very positive note with the best quarter of stock performance in many years, despite any substantive economic developments.
The US-China trade deal, which was scheduled to conclude 90 days from December 1st, remains an open negotiation. In January the US Government closed and reopened after experiencing its longest shutdown in history. The British and Continental Europeans continue to debate the terms of Brexit or an extension of negotiations; the initial March 29th deadline came and went with little reaction from market participants. Oil, which suffered a world-class drubbing leading into year-end, had a remarkable rebound. West Texas Intermediate crude oil, the US benchmark, bottomed on December 24th at $42.50 per barrel. Four months later, the benchmark is trading above $64 per barrel, a whopping 50% gain.
The Federal Open Market Committee (the “Fed”) did an about-face on its monetary policy. At year-end 2018, the market outlook was for two to three rate increases throughout 2019; now the market expects no rate increases and possible rate cuts. By late March, the three-month Treasury bill was briefly yielding more than the 10-year Treasury note, a condition referred to as a yield curve inversion, which when sustained, has historically been a precursor to economic recession.
Q4 gross domestic product (GDP) was recently reported at 2.2%, a very solid number for the $20 trillion US economy, even if it has slowed from higher rates over the past year (GDP averaged a very healthy 2.9% for 2018). Nearly all economic indicators are showing signs of slowing, but few are indicating an outright recession at this point.
The Fed’s Beige Book report showed continued growth in most districts. The report states economic activity expanded at a slight-to-moderate pace in March and early April, with most districts showing growth continuing at a similar pace from the last report, while some reported strengthening. Consumer spending was mixed, with sluggish general retail and auto sales. Labor markets remained tight, with employment growing at a modest-to-moderate pace in most districts. Wages continued to grow at a moderate pace. Prices rose modestly, with tariffs, freight costs, and rising wages cited as key factors.
We continue to find few undervalued stocks or bonds that meet our investment criteria. Selection remains challenging due to a general overvaluation across almost all sectors and asset classes. We concentrate on balance sheet, income statement, and cash-flow statement metrics when appraising a company’s value, true to our fundamentally oriented approach to security analysis.
The securities we hold in client portfolios represent good value, trading at attractive valuations with potential for significant unrealized appreciation. When we don’t hold stock or bonds, we hold cash, while we continue to search for attractive investments. We have been using 90-day Treasury bills as a cash alternative. We’ve done this by purchasing new 90-day Treasury bills approximately every 30 days, creating a laddered structure. This strategy currently yields about 2.4%.
We remain content to own a business while its fundamentals continue to show signs of improvement even if the stock price doesn’t immediately reflect the improvement. Over the years we have witnessed many stock investments fall in price as the business continues to improve, only to experience a “slingshot” like reversal when other market participants recognize the disconnect between the stock price and business value. As legendary investor Benjamin Graham said, “[stock] price is what you pay, [business] value is what you get.” We spend our time calculating and recalculating business value, allowing the stock price to take care of itself over time.
Our valuation methodology, as described above, relies on financial statement analysis supported by communication with company senior management and industry sources. Despite various alternative methods of analysis that become temporarily popularized by some emerging trend, we continue to believe that businesses have value to the extent they generate cash-flow – a hard point to argue. Our entire team remains committed to these rigorous research and analytical skills in search of further attractive investments.
Research Meetings & Conferences:
We speak with senior management regularly – generally each quarter as earnings are reported or other announcements are released. In February, we met with the senior management team of AutoWeb Inc. (AUTO) in their Los Angeles office. In March, we attended an investor conference in New York City and met one-on-one with the management of Wayside Technology Group, Inc. (WSTG). In early April, we traveled outside of Boston to meet with management and tour the recently renovated production facility of UFP Technologies, Inc. (UFPT). Finally, in early April, we met with the CFO and investor relations team of Subsea 7 S.A. (SUBCY) in Boston. In addition, we had well over 20 earnings conference calls and formal follow-up telephone meetings with companies in which we are invested or have an interest in investing.
In late March, Jeff was invited to a small group dinner meeting with James Bullard, President of the Federal Reserve Bank of St. Louis, hosted by the University of Wisconsin Department of Economics. Bullard was able to shed additional light on the current perspectives of the Federal Open Market Committee, of which he is a voting member this year.
Our entire research team remained active and engaged throughout the quarter, which leads to the next subject: shareholder activism.
In late 2018, we began putting pressure on Bristow Group, Inc. (BRS) as a result of the company’s announced acquisition, which we believed was poorly planned and financed. We have engaged with the company through both public and private communications. We have aligned with other stock and bond holders to pressure the directors and management to act in the best interest of owners and stakeholders – including employees, customers, and vendors. Our team has attracted overwhelming support from experienced and talented industry executives who will participate should we deem a proxy contest to be necessary. We’ve engaged legal counsel through Wilson Sonsini Goodrich & Rosati to step through related legal issues. Overall, we have a strong team and position as stockholders.
Clients of the firm should know we are proactive in holding company directors and management accountable and will engage in whatever way we deem appropriate and advisable to protect equity value for stockholders.
In the words of renowned investor Mark Mobius, “Stockholder activism is not a privilege – it is a right and a responsibility. When we invest in a company, we own part of that company and we are partly responsible for how that company progresses. If we believe there is something going wrong with the company, then we, as stockholders, must become active and vocal.”
From our Library:
As a firm, we have an internal “book club.” Nearly every week, we read a chapter from a selected investment book and meet to discuss it and share our views and impressions. We are currently reading Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism by Jeff Gramm.
Gramm makes the following statements, which we think every investor, active or not, should keep in mind when thinking about company ownership and committing capital:
…some investors decide to actively engage the company to try to enhance the value of their shares. This book focuses on the dramatic moment when a shareholder moves from passive observer to active participant and picks up a pen to plead his or her case.
Today no public company is too big to be confronted. Every CEO and corporate director is a potential target unless they have secured voting control of the company.
Finally, and of great importance:
Corporate America has a peculiar process that we must recognize. The managers of mature corporations with no concentration of owners have gotten themselves into the position of effectively selecting the board members who will represent the stockholders.
Often company management and directors have little or zero company ownership, while maintaining virtually all of the decision-making authority and access to the company’s financial resources. This can (and frequently does) lead to abuses that are difficult to prevent and counteract. Directorships are generally well-paid, prized positions. Stockholder activists frequently must pressure directors to provide ownership-like oversite or face the risk of being removed from office. Activists work for the benefit of all stockholders and other stakeholders.
We have one new addition to the Global Value team, our youngest yet. Tom and his wife, Paula, welcomed their son, Abe, to the world in early December. We are very happy for them and wish them well as they embark on the amazing journey of parenthood.
Our India office is preparing to expand, with a move to a larger office in Hyderabad. We anticipate adding a new associate over the next few months. Prakash and Satendar remain vigilant, providing their US teammates with global news and information flow on a daily basis, so that when the US team arrives to work, they are appraised of how Asian markets closed, European markets are trading, and US futures are poised to open. Our India office has proved to be an invaluable asset in our investment research and analysis process.
We remain mindful that we are investing other people’s money and as such have a great responsibility to apply rigor in every decision. The firm has a policy that each of its associates invest in the same issues we recommend. We appreciate our clients’ continued confidence, trust, and the kind words we hear as we attend to our work each day. Your support means a great deal to us, particularly when stress levels rise due to events beyond our control or increased price volatility.
If you’ve had a change in, or would like to update, your investment objectives or portfolio restrictions, please let us know so we can make appropriate adjustments. We recently filed our annual Form ADV with the SEC. Feel free to request a copy.
We remain committed to achieving long-term investment excellence by investing intelligently and opportunistically as situations arise. Please call anytime for a more detailed discussion of our strategy and market outlook.
Your Investment Research and Advisory Team
Global Value Investment Corp.