Peattie Capital

2019 continues to be a stellar year for Peattie Capital portfolios. For the most part, I haven't made any significant changes to core positions as I believe that the names we own will outperform the market in a "keep doing what you're doing" approach. The current earnings season is winding down, and so far nothing I've heard or read from current quarterly reports changes that.

Through August 9, most accounts gained roughly 30%, compared to a 18% total return for the S&P 500. A couple "constraint-free" accounts gained nearly 40%. The strong performance has been driven by stock selection, as any number of positions have gained over 50% and several have gained much more than that. Recall that Peattie Capital portfolios typically own 20-25 positions, and note that past performance does not guarantee future returns.

US Economy still ok

At the risk of repeating what I said in May, I think it's steady as she goes as the big economic numbers (employment and GDP) continue to be solid. The recent GDP report was mildly disappointing at 2.1% (expectations were for above 3%) but consistent 2% + growth in the 10th year of an expansion strikes me as pretty good and might be one reason (along with very low interest rates) why the market's multiple remains above the long- term average.

Housing starts and autos remain challenged, but with the recent interest rate cut the Fed has signalled its willingness to remain "market friendly." It's worth noting that historically the third year of a presidential cycle tends to be a good one.

That said, the President's tariff war continues to be a wild card on both the up and down sides. If the economy (and markets) show any real signs of faltering, I would expect a series of positive tweets about all the "progress" and "positive talks" the US is having with China. The tweets and knee-jerk response to them are stomach churning, and Peattie Capital portfolios own a couple names that are directly affected by higher tariffs. Ultimately the president controls the narrative around the trade war and he won't do anything to jeopardize his chances for re-election.

Globally, there are now $15 trillion of investment grade bonds trading with a negative yield (source David Rosenberg "Breakfast with Dave" August 7), and there has been a sharp drop in yields here in the US as well. The yield on the S&P 500 is roughly 2%, 25 basis points higher than the 10-year note, and as far as I'm concerned, most fixed income represents "return-free risk" at today's levels.

As always I am much more interested in earnings and individual companies but I also think it's helpful to recognize the overall environment and all things considered I think this one remains reasonably good for equities with the proviso that trade war headlines will cause volatility. Based on what I know today, I expect to hold (or add to) most current positions as selling them would generate massive capital gains taxes and also because timing the repurchase of them is too difficult to do consistently well.

Earnings have been good

Several large holdings in Peattie Capital portfolios delivered terrific results. Microsoft ("MSFT") and Alphabet ("GOOG"), are are two good examples, and shares in both responded favorably after they reported. MSFT will continue to benefit from the migration to the cloud, and GOOG will maintain its dominant position in search while awaiting any number of new projects to bear fruit. Both are generating vast amounts of free cash.

Once again ROKU delivered outstanding results, and shares bounced 25% in two days. ROKU appears to be in the middle of a steep S-curve, as advertising is becoming its main engine of growth, rather than selling devices/hardware. Shares have gained 309% in 2019 and it looks to me like they still have plenty of runway.

A few other names have had some interesting developments: Howard Hughes ("HHC") announced it had hired advisors to review strategic options as the company doesn't believe the share price reflects the value of it's assets. Shares bounced to about $130 from $105. Sealed Air ("SEE") reported better than expected numbers but the company has been under a cloud as it being investigated for the process by which it hired a new accounting firm in 2015. In response, the company began an internal investigation and subsequently replaced the CFO. IDEXX Labs' ("IDXX") Chairman, President and CEO, John Ayers, had a serious bicycle accident and is taking a medical leave. On several occasions over the years IDXX has had significant (30%) corrections, but the trends in pet care and the company's testing services are very powerful and enduring and I don't view the recent selloff as a reason to sell shares.

PayPal ("PYPL"), reported a number of solid metrics and guided up earnings slightly for 2019. However PYPL trimmed its full year revenue guidance as several large projects are taking longer to implement than expected. PYPL is benefitting from (a)the move to a "cashless" society, (b)the "network effect" of having increasing numbers of users and merchants, and (c) the "platform dynamic" resulting from partnerships with Visa and others in the payments system.

Management stated that the revenue is delayed, not lost, and I view the 15% (ish) selloff as a potential buying opportunity. The response to PYPL's earnings is a good example of how volatility is the friend of the long-term investor, and also a good example of the kind of company Peattie Capital likes to focus on.

I particularly like two small biotechs

Two smaller biotech companies have been terrific performers in 2019. One, The Medicines Company ("MDCO"), has a late-stage drug, Inclisiran, which is demonstrating success in reducing LDL cholesterol. MDCO reported positive data in May at the National Lipid Association meeting and will be reporting more data in Q3. While there has been a lot of attention on cancer treatments, cardiovascular disease remains the number one cause of death in the developed world today (source: company documents).

Even as MDCO shares have been rising (+72% YTD), insiders have been regular buyers. In June, the company did a follow on offering (at $33), and the Chairman added to his holdings. In addition, several Board members have extensive merger experience. Owning a company solely because it might be sold is not part of Peattie Capital's investment philosophy, but in this situation I like the progress the company is making and can't help but thinking it would be a good fit for a larger drug company experiencing patent expirations.

The other is Mirati Therapeutics ("MRTX") which has two "shots on goal." The first, sitravatinib, is being tested in humans with non small-cell lung cancer in conjuntion with another drug, nivolumab (Opdivo). The second is a KRAS inhibitor drug, MRTX849. Amgen ("AMGN") is also developing a similar KRAS inhibitor (AMGN 510) and recently reported favorable safety results in its firt human trials. Scientists have been trying unsuccessfully for forty years to crack the KRAS inhibitor, and there are signs that the time for that has come.

Both MDCO and MRTX are speculative, and are sized in client portfolios appropriately. Of the two, MRTX is more speculative, but the KRAS G12C mutation appears in approximately 13% of lung cancer patients, 3% of colon cancer patients, and 2% of all other solid tumors (source: company documents) and analysts believe AMGN 510 and MRTX849 would address an unmet need and might receive accelerated status if trials go well.

I still like Big Tech

While I'm at it, I might mention that I think investors would benefit from a breakup of the large tech companies such as Amazon and Alphabet. Broadly speaking, more focused companies get bigger multiples, and as an investor I would welcome seeing more detail about Amazon's AWS or Alphabet's YouTube, for example. There are any number of risks to these two companies, but I don't agree that regulatory risk is one of them.

Amazon has provided countless benefits to consumers as it has driven lower prices and greater efficiencies, not exactly the hallmark of a monopoly. The recent comment by a senior government official that Amazon had "destroyed retail" (paraphrasing) is off base, and possibly politically motivated as the Washington Post (owned by Jeff Bezos) is not friendly to the current administration.

Conclusion: Why Peattie Capital?

One final thought, which is a reminder that Peattie Capital manages separate accounts only, which benefits clients for two reasons. One, I can customize portfolios to specific client needs/constraints, and two, I can buy companies of any size. The biggest single holding across Peattie Capital is a $0.5bn microcap, far too small for almost any fund and not on anyone's radar as there is no Wall St. coverage. However, it's available and significant for say, a $10mm-$15mm private account.

An article in the July 29 WSJ "Investors Favor Fewer Stocks, Leading to Crowded Trades" discusses herding and lists the 20 most widely held stocks (Peattie Capital only owns three of them). The article cites a Bank of America Merrill Lynch stating "the overlap in the top 50 stockholdings between mutual funds and hedge funds-two types of investors whose styles typically differ-now stands at near record levels....."

To summarize, Peattie Capital creates customized accounts that do not hold the most widely held names, has delivered market-trouncing performance, offers a flexible operating model with no lockups, and has a "user-friendly" compensation structure starting at 1% annually with no performance sharing.

A couple clients and prospects have asked about owning T-bills, either temporarily or as part of their overall wealth management strategy. Peattie Capital's tagline is "Invested in the individual" (I like the alliteration-I think it's alluring) and I'm happy to accommodate that. There are no fees for any assets in fixed income.

Please don't hesitate to contact me with questions or comments.

Most Peattie Capital companies have reported Q2 earnings, and volatility is back, so I thought it would be an appropriate time to make a few comments.

Performance update

Broadly speaking, client portfolios continue to outperform the major indices with most gaining in the low 20's (net) through May 10, compared to a total return for the S&P 500 a little over 15%. A couple accounts have gained in the high 20's. Past performance does not guarantee future returns.

US Economy

Steady as she goes as the big numbers (employment and GDP) continue to be solid. That said, a few things under the hood are mildly concerning: the charge-off rate for major credit card issuers hit a seven-year high of 3.8% in Q1, overall demand for loans (consumer and commercial) are falling (source: David Rosenberg morning notes May 7), the yield curve fluctuates between very flat and kinked, and commodities are softening.

Overall, the S&P 500 trades at 3x book value, 20x trailing earnings and roughly 16-17x forward earnings. The Schiller P/E ratio is about 30x and Warren Buffett's "market cap to GDP" ratio is about 1.5x.

On the other hand, the "Rule of 20" says that the market's multiple should be 20 minus the inflation rate, which would suggest something a little over 18x.

So, depending on who and what you believe, the market is expensive. Or it's not.

If the markets were concerned about recession, I would expect the high yield ETF ("HYG") to be soft on days when equities sell off. For example, on Friday, March 22, the S&P dropped 1.9% and several days last week there was pressure....each time HYG barely budged. My conclusion is that the recent volatility has more to do with China trade talks than fundamental weakness.

One reason I favor stock picking is that it's just too hard to be consistently right about what the world is doing, let alone predict how the markets will respond to that and be positioned to profit from it.

Stock picks

Companies in Peattie Capital portfolios continue to deliver terrific results, and a number of share prices have jumped 25%-45% this year. The star of the show has been Roku ("ROKU") which reported a variety of better-than-expected metrics last Wednesday, and shares soared 28% Thursday. In 2019, ROKU has gained 170%.

DuPont ("DWDP") and Grubhub ("GRUB") have been poor performers. DWDP mentioned weakening fundamentals and is in the process of splitting into three companies so is probably seeing shareholder turnover. GRUB is facing an abundance of competition, but the CEO bought $1mm of shares (at $64.87) after the company reported and he has said that "Other companies can't do what we do." I'm inclined to hold these for now but either may become a source of funds.

Sealed Air's ("SEE") CEO also bought shares (at $45) after the company reported, and one of the two drug development companies in most portfolios is reporting data at a conference Saturday, May 18. I know it's redundant, but I like the names in our portfolios, which is not to say everything will go up in a straight line.

Pivot to include more growth

Several years ago I began including a few more growth-oriented names, on the belief that the impacts from the internet would be very long lasting, and that migration to the cloud represented a massive and relentless infrastructure overhaul. Needless to say, I'm glad I did. The world continues to change right before our eyes and including names that are driving that change has been one of the best investment decisions I have ever made.

According to Joe McAlinden's April 29 Daily Intelligence Briefing "total worldwide IT spending is projected to reach $3.7 trillion in 2019, representing an increase of 3.2% from 2018 and 8% from 2017." Digital transformation has become a top priority for businesses of every size and in every industry and country in the world as far as I can tell.

That said, I do not consider Peattie Capital to be a "growth" or "tech" investment vehicle but rather a flexible and opportunistic generalist.

Concentration has also been an important and distinguishing factor in Peattie Capital's performance. By way of reminder, portfolios tend to own 20-25 positions (a few older ones have slightly more) as I believe focusing on the best opportunities provides the best chance for investment success.

Charlie Munger's approach of "wait for the fat pitch and then bet heavily" is appealing but maybe a tad too focused for me. Another of my favorite portfolio managers, Chase Coleman, tends to have 30 or so positions, with the top few very large, and the top 10 usually represent 50%+ of the portfolio.

Peattie Capital's wall of worry

1. Jeremy Grantham says the market will "break a lot of hearts" the next 20 years, and deliver real returns in the 2%-3% range on average. In a related item, Warren Buffett says Berkshire Hathaway will have trouble outperforming the S&P going forward but at a smaller size it could earn 50% annually. Let's hear it for small, focused, and individual stock picking!

2. Inflation is running below 2%, but labor is tight and if we experience wage-driven inflation a spike in rates would accompany it. Higher rates would be a headwind for equities, but thus far there are no signs of that. That said, one of the prevailing comments during earnings season has been the difficulty of finding good employees.

3. According to the April 29 Barron's, (interview with Tim Johnston of Sandhill Investments) one-tenth of the top 1% own 12% of our national wealth.

4. Overwhelming global debt.

5. The US Federal deficit is now nearly $22 trillion, or 107% of US GDP. Politicians say this doesn't matter, but US dollar reserves were 85% of global reserves in 1977 and now are 62%. Someday, the rest of the world may not actually show up in droves at Treasury auctions. (source: IBID)

6. Global climate change

7. Since the Civil War, interest rate cycles have lasted 30-35 years. Rates peaked in the early 1980's....do the math. Higher rates would be a headwind for equities. Oh, wait, I already said that.

8. Lyft ("LYFT") and Uber ("UBER") have not held their IPO price. Not an issue for early-stage investors but not so good for public market investors. Sidebar: Beyond Meat ("BYND") peaked at $85, a valuation of $4.4bn, or 50x sales. (!!) Even by tech standards that's ridiculous... .and it's a food company. Sidebar#2: For a variety of reasons, Peattie Capital does not participate in IPOs.

9. US demographics are not pretty. People are getting married later and having fewer children, which, broadly speaking, is understandable given the crushing student debt many young people carry. Combine this with restrictive immigration, and ultimately you limit future economic growth. (Source:Rosenberg May 7)

10. Revenue and earnings growth are still positive, but they are declining.

Recently I've been asked

1. Why do you favor such concentrated portfolios?

2. If you could only own one company what would it be?

Answers:

The studies I've seen indicate that as few as 8-10 properly chosen positions provide sufficient diversification. Murray Stahl, Managing Partner of Horizon Kinetics, and another of my favorite investors, said in his April Market Commentary

"The term 'diversification' has come to be understood-or hijacked, depending on your attitude-as having many holdings across many asset classes and sectors. That is not its true meaning or purpose. Its purpose is to reduce overall risk by having some holdings that are subject to different risks or opportunities than others. It could well be an instruction for very few holdings, but which are very independent of everything else.

Another investor once called it de WORSE ification.

I agree with both of them, and that's why, absent specific constraints from clients, I prefer individual securities, rather than asset classes or styles. Peattie Capital is comfortable owning different types of names (sizes, growth characteristics, etc.) in the same portfolio, with bigger exposure to the names I like best.

These days there's just not enough value for me in bonds, although I understand their role in wealth preservation (note: I spent the first 10 years of my career in fixed income). I think this environment still favors equities and I frequently say that I "live in an equities world".

As to #2, I can't name just one. Different companies suit different needs at different times. I recently read that NVR ("NVR") has bought back 67% of its shares in the past 20 years, similar to Texas Pacific Land Trust ("TPL") whose mandate is to buy back shares. I also like Heico ("HEI") very much.

For clients seeking long-term wealth/capital appreciation I think these are wonderful holdings, but for clients who expect me to beat an index in a specific time frame they may not be as suitable.

HEI is in most portfolios, TPL in a few, and I expect NVR to be in some portfolios shortly.

One housekeeping item: no fees for T-bills

A couple clients and prospects have asked about owning T-bills, either temporarily or as part of their overall wealth management strategy. Peattie Capital's tagline is "Invested in the individual" (I like the alliteration-I tink it's alluring) and I'm happy to accommodate that. There are no fees for any assets in fixed income.

Please don't hesitate to contact me with questions or comments and just let me know if you'd like to be removed from distribution.

Greetings all,

Several people responded favorably when I used this format for the Q4 Peattie Capital update, so I will use it again. Earnings season is mostly over, so there is time to share a few thoughts.

A word on performance

Q4 last year was brutal, and the selloff spared no one. For 2018, the best performing Peattie Capital account (net of fees) was +5%, and the worst was -7%, compared to a total return of (4.2%) for the S&P 500. Most accounts were clustered on both sides of 0%. Note, individual accounts vary based on specific client goals and constraints, and these data apply only to accounts that were open the entire year. Past performance is not a guarantee of future returns.

The selloff created some wonderful buying opportunities, and 2019 is off to a great start. Through March 8, the total return of the S&P 500 is up a little below 10%, and most PCM portfolios are well ahead of that, with returns mostly in low/mid-teens. The best has gained about 21%.

As for companies, the runaway best performer YTD is Roku (+130%), followed by Mirati Therapeutics (+60%), and several companies have gained 20%-35%. Recall that most Peattie Capital portfolios have approximately 25 positions.

This weekend’s FT has a nice article (Michael Mackenzie’s The Long View) which addresses what I’ve been saying about highly correlated fund flows driving markets further and faster than ever before. “..the relentless rise of electronic trading (has) triggered rapid shifts across all main markets in unison alongside vast flows of money that track indices-which has left markets more vulnerable to herd mentality....” As a long-term investor, I expect volatility, and plan to take advantage of it judiciously.

The macro picture

I’ve said regularly that I’m far more interested in individual stocks and earnings power than I am in macro events. Brexit, China trade issues, politics, the Middle East all make for attention-grabbing headlines but are only peripheral in my stock selections. That said, a global economic slowdown would likely impact overall S&P earnings growth. As Jamie Dimon said in the JP Morgan earnings call (paraphrasing) JPM isn’t predicting a recession but they are prepared for one.

In his annual letter, Warren Buffett wrote “In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good. Prices are sky-high for businesses possessing decent long-term prospects.”

It’s noteworthy when experienced luminaries with insights like these two say “prepared for a recession” and “prices are sky-high”. Additionally, Fed Chairman Powell testified Feb. 26 that current economic conditions were “healthy” and the outlook was “favorable” but cautioned “over the past few months we have seen some crosscurrents and conflicting signals.”

With inflation negligible and “crosscurrents” appearing (the March 8 employment report was particularly disappointing), I think the odds of further rate hikes in the near future are very low. In addition, Powell has pivoted to a neutral stance. The yield curve remains very flat, but not inverted, and I think 2% (ish) US GDP growth is a reasonable expectation. If forced to name an issue, it would be unexpected inflation as wage data from the employment report were mildly concerning (+3.4% average hourly earnings growth, the strongest in a decade according to a Wall St Journal editorial this weekend).

I don’t think the indices are in any major danger, and I also don’t think there is a case that the markets are “cheap.” We’re approaching the 10-year anniversary of this bull market which benefitted from declining and historically low rates, and oceans of government-provided liquidity. It seems to me that individual stock picking is the best choice at the moment.

As for Peattie Capital, while I think it’s important to know the overall environment, I am more focused on:

• Any number of ongoing, and intractable trends and platforms
• Underfollowed, unknown, and under-owned companies, which aren’t correlated to the S&P
• Anything cheap, especially if there is a nearby catalyst(s)
• Companies that can “make their own weather”

Sample ongoing trends

Migration to the cloud, which cuts across every industry in every country, and the “digital ferrymen” who manage that process. Examples: Epam, Globant, Veeva Systems

Millenials, who like “experiences” not “things”. Examples: cruise lines, Vail Resorts, Cedar Fair

Free time, which continues to accrue to media, and the resulting insatiable demand for content. Examples: World Wrestling, Manchester United

Entrenched retailers, who are struggling to compete with disruption (these are short candidates, and only for a few clients). Examples: Edgewell, Tempurpedic

Mistrust and “routing around” large institutions. Example: Kraft Heinz, which announced in January that its Kraft Natural Cheese “is now made with milk from cows raised without the artificial growth hormone rbST”....hmmmmm, wonder why it was called “Natural” in the first place. (Source: FT John Gapper Feb. 28)

Healthier eating and changing food distribution. Example: Kraft Heinz, which just took a $15bn charge and CEO Jorge Paulo Lemann said “I’m a terrified dinosaur. I’ve been living in this cozy world of old brands and (big) volumes....all of a sudden we are being disrupted in all ways. We bought brands and we thought they would last forever. Now, we have to totally adjust to new demands from clients....”

Sidebar: I am not a fan of Kraft Heinz, which epitomizes the changing landscape. That said, in the low $30’s it might be a takeover candidate.

The end of appointment TV, which is being disrupted by streaming.....and the end of other appointments too. Think telemedicine.

Companies that are interested in “doing good” as opposed to trapping customers (Oracle) or finding more ways to extract revenues from them for the same or less service (airlines and cable companies with their never-ending add-on fees. What is a convenience fee anyway?) See Dan Schulman quote below

A couple more interesting comments from CEOs:

“It is amazing how increasingly short-term oriented the public equity markets have become. The frenetic turbulence triggered by hyperactive and often automated fund flows can result in excellent investment opportunities for long-term patient investors.” Michael Landry, CEO and President, Monmouth Real Estate. My two cents: Couldn’t agree more!!

“Businesses need to be a force for good in those values and issues that they believe in. It shouldn’t come from backlash or people taking heat on it, because then it’s in response, as opposed to the definition of who you are....” PayPal CEO Dan Schulman WSJ Feb. 25. My two cents: Yes, I think there is an emerging trend here, and I’m paying a little more attention to corporate culture.

“Society is looking more towards the business world for social stewardship, more so than governments. Corporate social responsibility is no longer optional.” Larry Fink, BlackRock CEO. My two cents: I am somewhat surprised at how big the ESG movement has become. I’m not sure if companies that score well on this metric will perform any better, but I think over time it will become more important to investors that companies pay attention to their ESG footprint.

Comments on a few widely-held positions

Dollar Tree (“DLTR”) bought Family Dollar (“FDO”) a couple years ago but has struggled to integrate it as there are issues around operations and price-points. Shares rose 5% on March 6 after DLTR announced the closing of a number of FDO stores and said most merger-related costs were completed. It’s no longer cheap at 19x forward estimates, but there is a path to significant gains if the restructuring succeeds. Three activist investors are involved.

Mirati Therapeutics (“MRTX”) has two potential new drugs. Shares have rocketed this year (+60%) and now it’s a waiting game for more data.

TenCent (“TCEHY”) gave back some of its huge gains last year, but nonetheless was a big performer since I bought it mid-2016. At a $400bn market cap I am concerned that Chinese authorities just won’t let it grow significantly and I sold all shares.

DowDuPont (“DWDP”) announced Friday March 8 that the spinoff of Dow Chemical will be on April 1, creating three independent businesses. Most analysts value DWDP at $67, on a sum-of-the-parts basis, and with shares currently about $54, that suggest nearly 25% upside. Prior to DWDP, CEO Ed Breen had great success splitting Tyco, with shares gaining about 17% per year in the ensuing decade. (Source: Barron’s March 11, 2019)

Epam (“EPAM”) What a juggernaut, and perfectly positioned to continue assisting others in the ongoing migration to the cloud. The biggest challenge, which so far they have met, is finding enough qualified employees to meet demand.

PayPal (“PYPL”), Texas Pacific Land Trust (“TPL”), and Idexx Labs (“IDXX”) which I believe to be 15-20% annual growers for the next several years. The question is what multiple does that deserve?

Independence Holding (“IHC”) is the largest holding across PCM portfolios and also about the smallest at $.5bn. The CEO has a nice incentive (3% of value) for sale of any division. IHC has been a wonderful performer and I expect more gains. Ever heard of it? I didn’t think so....that’s Peattie Capital’s edge.

Currently looking at

Eagle Bulk Shipping (“EGLE) has a $300mm market cap and is down, down, down, and out, out, out. Shipping is about as cyclical as it gets, and also suffers from extended supply/demand mismatches...a classic commodity trait. This is not a name to own forever, but when the cycle turns and demand grows while supply is shrinking, companies in the industry can earn more in one year than their current market cap. There are issues, but getting it right can lead to massive gains, which are not likely from the indices as I said above. Also, there are no shipping companies in the S&P 500, except for cruise lines. Stay tuned, giving this one a good look.

Please feel free to contact me with any questions or comments and thank you for being a part of Peattie Capital!

Best regards,

Bill