Not a nice way to kick off 2016. These few trading days have seen substantial volatility across equity and currency markets driven by increasing concerns of a Chinese hard landing.
We have long been in the “bearish” China camp given our view that many of the growth drivers are unsustainable – click here to see Brandon’s thoughts back in 2013. While our overall cautious view has shaped our portfolio positioning, including cash levels and sector allocations, the fact is that during periods of very high volatility (like today) correlations can move significantly higher. This often punishes companies similarly even though in many cases it is not deserved.
Today, we are seeing many “babies being thrown out with the bathwater”.
While not fun, these times create some excellent longer term opportunities for patient investors. In fact, I am seeing more examples of specific security mispricings today than I have seen in some time. While macroeconomic risks do remain and could very well result in continued volatility, these are the times you are able to find excellent risk/reward investments that rarely exist during periods where risk appetite is high and everyone feels there is little to be worried about. Think back to many of the very speculative IPO’s of the past couple years that came to market with much fanfare and little to no earnings in sight.
One example of a “baby” is an existing holding which I thought was very attractive six months ago. Since then this stock is down 20% (similar to other businesses in the sector) however the concerns plaguing peers have little to no impact on this business. This was confirmed though a CEO/CFO meeting and subsequent update call.
After this most recent decline, this company boasts a >4.5% yield supported by a >8% free cash flow yield. More interestingly however, is that this free cash flow yield is despite the company investing heavily to upgrade many of its assets. When its assets are fully upgraded over the next 15 months, not only will this business be growing even faster (allowing them to further raise the dividend after boosting it in 2015) but its capital spending will decline bringing the free cash flow yield to well over 10%. Business improvement initiatives, a solid consumer value proposition, strong free cash flow, ongoing asset improvements, resilient end markets and intelligent asset allocation – at this low price - make this an investment we believe provides our fund holders with excellent risk/reward over time. To take advantage of the even more attractive risk/reward, we have increased the position size across a number of funds.
Does this mean the stock can’t decline in the short term? It certainly could.
Do I believe there is low risk of losing money over a reasonable length of time? Yes. Also, time is on our side as we collect a nice yield, let management grow the business and wait for the market to recognize the value.
We are fortunate to be finding more and more of these businesses today – even though we do remain concerned with some specific macroeconomic risks. While volatile times in the markets are not enjoyable, they can create some excellent opportunities.