RiverPark Focused Value Fund

Transcription

1 RiverPark Focused Value Fund (RFVIX / RFVFX) Our investment philosophy is simple, consistent, and durable. We are rigorous, research-oriented, fundamental value investors. You should expect us to understand deeply the businesses in which we have invested our shareholders capital and, in each situation, to have a quantitative framework for how we expect to earn an attractive compound return over a multi-year holding period. RiverPark Focused Value Fund (the Fund) represents a significant investment for me and the RiverPark team. Our goal remains to earn your trust and confidence in our value-oriented approach to investing. First Quarter 2018 Performance Summary In the first quarter of 2018, the Fund returned -5.87% as compared with the total return of the Russell 1000 Value Index of -2.83%. The total return of the S&P 500 Index was -0.76%. Performance: Net Returns as of March 31, 2018 Current Quarter Year-to- Date One Year Since Inception Institutional Class (RFVIX) -5.87% -5.87% 8.05% -1.55% Retail Class (RFVFX) -5.87% -5.87% 7.80% -1.79% Russell 1000 Value Total Return Index -2.83% -2.83% 6.95% 7.87% S&P 500 Total Return Index -0.76% -0.76% 13.99% 10.77% Performance quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor s shares, when redeemed, may be worth more or less than their original cost and current performance may be higher or lower than the performance quoted. High short-term performance of the fund is unusual and investors should not expect such performance to be repeated. For performance data current to the most recent month end, please visit the website at or call Expense ratios as of the prospectus dated 1/25/2018: RFVIX 0.87% (gross); 0.91% (net); RFVFX 1.28% (gross) 1.25% (net). Fee waivers are contractual and subject to annual approval by the Board of Trustees. Index returns are for illustrative purposes only and do not represent fund performance. Index performance returns do not reflect any management fees, transaction costs, or expenses. Indexes are unmanaged and one cannot invest directly in an Index. 1

2 Portfolio Summary Investment returns for the first quarter lagged on both an absolute and a relative basis. As discussed in previous letters, the degree of concentration in our portfolio has the potential to deliver significant performance deviations from our benchmarks. While our goal is to deliver strong absolute and relative performance over time, we understand that there will also be periods, like this quarter, where our performance lags. As has been our practice over time, we generally used price appreciation to reduce positions and price declines, in the absence of a change in our investment thesis, to add to positions. We believe our portfolio remains significantly undervalued and has the potential to deliver substantial absolute and relative returns from current levels. During the quarter, we initiated a position in CarMax Inc., which is described later in this letter, and eliminated our position in Calpine Corp. shortly before its acquisition for cash by a private equity firm. Our cash position at quarter-end was approximately 8.8%. See below for our top ten holdings, as well as the positions that most significantly contributed to and detracted from performance during the quarter: Top Ten Holdings as of March 31, 2018 Percent of Net Assets Marathon Petroleum Corp. 8.6% Western Digital Corp. 5.1% Alliance Data Systems Corp. 5.0% Vistra Energy Corp. 4.9% AerCap Holdings N.V. 4.8% Macquarie Infrastructure Corp. 4.5% CarMax Inc. 4.3% The Blackstone Group L.P. 4.3% Lear Corp. 4.3% Liberty Global PLC 4.2% 49.9% Numbers may not sum to total due to rounding. Holdings are subject to change. Current and future holdings are subject to risk. 2

3 Top Contributors to Performance for the Quarter ended March 31, 2018 Percent Impact Top Detractors from Performance for the Quarter ended March 31, 2018 Percent Impact Marathon Petroleum Corp. 1.01% Colony NorthStar, Inc % Western Digital Corp. 0.73% Macquarie Infrastructure Corp % Vistra Energy Corp. 0.56% Alliance Data Systems Corp % Las Vegas Sands Corp. 0.30% Magellan Midstream Partners LP -0.50% Qurate Retail, Inc. (formerly Liberty Interactive Corp.) 0.17% Liberty Global PLC -0.45% Portfolio Attribution is produced by RiverPark Advisors, LLC (RiverPark), the Fund s adviser, using the FactSet Research Systems Portfolio Analysis Application. Although RiverPark believes that the FactSet model adheres to generally accepted standards in the industry, attribution analysis is not an exact science and different methodologies may produce different results. Performance attribution is shown gross of fees. Holdings are subject to change. Portfolio Initiations: CarMax Inc. (KMX) During the quarter, we initiated a position in CarMax, the largest retailer of used cars in the US. KMX is an excellent business with both a differentiated business model and scale advantages that create a barrier to competition. Since its founding, interestingly as part of the now-defunct Circuit City chain, KMX has aimed to deliver a superior customer experience to used car buying and selling, incorporating features such as no-haggle pricing, increased selection, and price/quality guarantees. 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. In a highly fragmented market that has historically been characterized by aggressive sales techniques, 1 KMX delivers a consumer-friendly approach to each step in the used car experience: Selling a car to KMX: CarMax provides a written offer for the customer s existing vehicle that is independent of whether the customer buys a car from KMX. This offer is guaranteed for seven days and the customer is welcome to shop around for a better deal. Buying a car from KMX: CarMax offers no-haggle pricing. Customers can access the company s entire nationwide inventory of more than 65,000 vehicles, each of which has been reconditioned to KMX s exacting standards. Each vehicle sold come with a five-day money-back guarantee and a 30-day limited warranty. Try getting that from your local used car dealer! 1 A 2012 Gallup poll rated car salespeople as the least trusted profession with only 8% of respondents ranking their honesty and ethical standards as high or very high. Car salespeople were the only profession to rank lower in this category than members of Congress ( 3

4 Financing and other services: Customers are welcome to pay cash, bring their own financing, or access financing from KMX or its lending partners. All financing offers are backed by a three-day payoff option if the customer can find a better deal from another lender. KMX also offers extended service plans and other products that help build customer satisfaction and loyalty. 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. 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. The market for used cars is dynamic and influenced by many factors including the behavior of new car manufacturers and rental car companies, the overall economy, interest rates, and gasoline prices. KMX has the broadest reach and the most market knowledge in a fragmented and nontransparent market which provides an enormous advantage over smaller competitors. KMX profitability comes from four sources: selling used cars to consumers, providing financing to used car buyers, selling other services like extended service plans, and selling used cars at auction. Over the past 15 years, revenue has grown at more than 10% per annum through a combination of new store openings, increased unit sales at existing stores, and modest price appreciation. Operating leverage has driven greater growth in net income (14.5% per annum), and share repurchases, beginning in 2013, have enhanced per share earnings growth to more than 15% per annum. CarMax s core market is lightly used cars (less than 10 years old). 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. 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 4

5 or the company becomes more aggressive in share repurchases, there is additional upside potential to these expected returns. Portfolio Updates: Macquarie Infrastructure, Inc. (MIC) and Colony NorthStar, Inc. (CLNS) Two of our holdings, Colony NorthStar and Macquarie Infrastructure, announced disappointing results this quarter and the share price of each declined substantially. As is shown in the table on page 3, these two securities alone were responsible for nearly all of our losses this quarter. We have invested substantial effort analyzing these results, reassessing the companies prospects for the future, and reevaluating our investments in light of new facts and reduced share prices. In one case, we decided to increase our investment. In the other, we concluded that our investment was too large and sold approximately half of our position. Macquarie Infrastructure, Inc.: As its name implies, MIC owns and operates several infrastructure businesses including storage tanks, power generation, and general aviation airports. Almost 70% of the company s cash flow has historically been derived from businesses that have been stable, strongly cash flow generative, and subject to annual or multi-year contracts. While MIC is not a Master Limited Partnership (MLP), it acts like one, paying out the majority of its free cash flow to stockholders in the form of a regular dividend. Over the last five years, MIC management has produced an enviable record of growth and stability, increasing its quarterly distribution to stockholders at nearly 16% per annum. 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. Our experience analyzing IMTT and competitors marine terminal businesses supported our belief that IMTT is a durable business. During the company s fourth quarter conference call, MIC projected that IMTT occupancy would decline from an average of 93% in 2017 to the mid-80% range in 2018, leading to reductions in projected revenue and operating income of 7% and 12% respectively. Management attributed this impairment to developments in the market for residual fuel oil ( resid ), the heavy dirty stuff that is a by-product of crude oil refining literally, the bottom of the barrel. The market for resid in North America has been under pressure for several years as more stringent environmental regulations have limited demand. Increased production of lighter crudes and improvements in refining processes have reduced supply. Given the historical performance of IMTT, this development was extremely surprising. Although the company had previously disclosed that 55% of IMTT s revenue was derived from refined petroleum products, it had not disclosed how much of the business was reliant on resid. Since resid is typically 5

6 around 2% of a refiner s output, we believed that the impact of structural declines in this market would have remained within the company s historic occupancy range. In announcing results for Q4 2017, the company acknowledged that resid storage actually represented more than 10% of IMTT revenue and that several customers who had been trading and storing resid in MIC s facility in St. Rose, LA had exited the business. MIC management further announced that to replace these customers and reduce its exposure to the challenged resid market, it planned to invest $225 million over the next three years to reposition these tanks to hold alternative products. In order to be prudent with respect to leverage and maintain an investment grade credit rating, they decided to fund these and other capital projects from internally generated cash flow over the next few years and would therefore distribute a smaller percentage of cash flow to shareholders. The decrease in earnings from IMTT, coupled with the alteration of its financing and payout philosophy, led to a 30% cut in the dividend. The stock declined even further (by 40%), driving the dividend yield, which we thought was already high at nearly 9% per annum, to more than 10%. We believe that the extreme reaction of the share price was the result of sales by dividend-oriented shareholders whose initial response to dividend cuts is often indiscriminate selling. Further, the bad news was delivered by a new CEO who had been on the job only a few months. Business uncertainty compounded by managerial uncertainty may also have played a role in the sharp share price decline. Since the announcement, we have had numerous conversations and meetings with management of MIC and other industry participants to better understand what caused the operational issues at IMTT, to determine whether we thought they were contained and being properly addressed, to assess management s ability to resolve the problems, and ultimately to decide whether, as investors, we were being properly compensated for the risks of the business at the new, greatly reduced share price. 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. 6

7 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. Colony NorthStar, Inc.: CLNS is a real estate investment trust (REIT) that was created in January 2017 through a three-way merger among Colony Capital, NorthStar Realty Finance, and NorthStar Asset Management. As a result, the company has a somewhat complex structure: owned real estate in three market segments: healthcare, industrial, and hospitality; an investment management business; and a portfolio of other investments. At the time of the merger, management presented what at the time seemed like a credible plan to transform the company from primarily real estate ownership to a more capitalefficient opportunistic real estate asset manager. This transformation was to be achieved through asset sales, the transfer of owned assets to managed vehicles, and organic growth in the investment management business. If management had achieved these objectives, it would likely have resulted in higher margins, more stable earnings, and a better valuation multiple. We thought it reasonable for a transformed CLNS to trade at more than $20 per share, up about 50% from our initial purchase price, as the company would be valued based on a multiple of cash flow/funds from operations rather than on the basis of Net Asset Value (NAV), that is, total assets minus total liabilities. Further, the dividend yield of nearly 8% enhanced our projected total return to nearly 60%. During the first nine months of Colony s existence as a public company, developments unfolded consistent with management s plan as they announced the sale of certain owned assets to a managed vehicle, the divestiture of a non-essential division within asset management at an attractive valuation, and the realization of post-merger synergies. Notwithstanding these positive internal developments, toward the end of 2017 and into early 2018 rising interest rates and the declining value of healthcare assets in the public markets generally weighed on the stock. We applied these market adjustments to our valuation for CLNS and estimated a decline of approximately $1 per share while the market value of CLNS had declined by nearly $4 per share, thus improving the value proposition. During the fourth quarter conference call held in March, however, management made several announcements demonstrating that progress towards its pre-merger strategic initiatives was going to take longer than we had previously anticipated. Returns on the investment portfolio would be lower in 2018 than 2017, income from asset sales was delayed, and most importantly, growth in the asset management 7

8 business was lower than expected. They also reduced the quarterly dividend from $1.05 per share to $0.44 per share. In response to these announcements, the stock declined by an additional 25% from approximately $8 to less than $6. In the following weeks, we engaged management numerous times to understand better the assumptions underlying the valuation of Colony s investment portfolio and assess their capacity to generate value for shareholders by streamlining the company s complex corporate structure and creating a more asset-light real estate investment vehicle. In the three owned real estate verticals, we reset our valuations. We determined the healthcare and hospitality assets were worth less than we had initially estimated while we maintained our value for the company s industrial properties. The portfolio of other real estate securities also suffered minor impairments. The most significant impairment to our valuation was the business to which we ascribed the highest multiple investment management. In this area, management has been less successful in raising capital than they and we had hoped. In order to retain clients, they have had to restructure some of their funds investment management agreements to reduce fees. Clearly, the transformation process has not been as smooth as we had hoped and some of our original estimates of value have proven to be optimistic. In aggregate, our estimate of value has declined from more than $12 per share when we initiated the position, to roughly $9 today, with more than 40% of the decline attributable to the investment management business and about 35% to reduced valuations in healthcare and hospitality. At the same time, the stock price has declined from $12 to less than $6. Normally, when we find that the underlying value of the assets is far greater than the current stock price (as we discussed above with respect to MIC), we view that as a buying opportunity. Here, however, our initial assessment of Colony s management as smart, opportunistic investors has been somewhat shaken by our recent experience. Tom Barrack, the CEO, highlighted his personal commitment to resolving the merger issues, and we are convinced that he is both sufficiently and properly motivated to fix the problems. Given his prior track record, we remain invested in CLNS (although the position has been significantly reduced) while we wait for some evidence that his do/say ratio (see below) will improve. Should we observe successful execution against this plan, we remain open to increasing our position. Investment Strategy The Do/Say Ratio: Value investing is an area with very few new or original ideas. The strategy of buying durable, predictable, well-managed businesses at reasonable prices is something we have been practicing, reading, and writing about for over 25 years. Nevertheless, we sometimes find a new framework for describing our core investment principles that help us refine our process. During the quarter, we heard Gary Heminger, CEO of Marathon Petroleum Corp. (MPC), currently the 8

9 Fund s largest investment, speak at an investor conference. In previous letters, we have written about our thesis for MPC. The investment has evolved consistent with our projections, leading to an approximate 15% compound annual return over our holding period while still representing a compelling investment opportunity. Having owned the stock since 2015 and read annual reports since it became an independent company in 2011, we believe that much of the company s success is due to management s focus on using capital allocation to build per share value. Mr. Heminger said: when you look at total shareholder return and executing our plans, the thing that we have been striving to get across to Wall Street and to get across to our investors is that we strive to have a very high say/do ratio that is, if we tell you we're going to do something, we're going to execute on it. 2 We believe that the very best management teams tell us what they plan to do and then successfully do what they say. We prefer consistency in these plans, as has been the case with MPC since 2011, and coherence across various methods of communication and action. We like companies, like CarMax, where the message of success through building a superior and differentiated customer experience, is the same when communicating with customers, employees, and investors. The do/say framework has helped us think more clearly about investments we have made throughout our careers. In retrospect, many of our most successful investments had management teams with high do/say ratios. Sometimes a company s previously high do/say ratio declines over time, and in those cases, we would generally have been well served to be more skeptical in the reassessment of our investment thesis. Going forward, we will continue to increase our exposure to certain investments and decrease exposure to others based on application of the do/say framework. Conclusion Thank you for your interest in the RiverPark Focused Value Fund. We continue to believe we have a durable and differentiated investment process that can deliver attractive returns over time. We have identified a portfolio of well-managed, high-quality businesses at reasonable valuations that we believe offer compelling return potential over the next several years. We look forward to updating you in future letters. Sincerely, David Berkowitz Portfolio Manager and Co-Chief Investment Officer 2 Credit Suisse Energy Summit, Vail, Colorado, February 13,

10 To determine if a Fund is an appropriate investment for you, carefully consider the Fund s investment objectives, risk factors, charges and expenses before investing. This and other information may be found in the Fund s summary or full prospectus, which may be obtained by calling or by visiting the website at Please read the prospectus carefully before investing. Mutual fund investing involves risk including possible loss of principal. In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from social, economic or political instability in other nations. The Fund may invest in securities of companies that are experiencing significant financial or business difficulties, including companies involved in bankruptcy or other reorganization and liquidation proceedings. Although such investments may result in significant returns to the Fund, they involve a substantial degree of risk. There can be no assurance that the Fund will achieve its stated objectives. The Fund is not diversified. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular. Russell 1000 Value Index measures the performance of those Russell 1000 companies with lower priceto-book ratios and lower forecasted growth values. The index was developed with a base value of 200 as of August 31, S&P 500 Index is an unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic equity market through changes in the aggregate market value of 500 stocks representing all major industries. Investors cannot invest directly in an index. The RiverPark funds are distributed by SEI Investments Distribution Co., One Freedom Valley Drive, Oaks, PA which is not affiliated with RiverPark Advisors, LLC or their affiliates. 10