Portfolio Roundup

I continue to hold a handful of positions-- five, to be precise. I believe these positions are significantly undervalued and provide large upside.

1. The largest position I hold is Bank of America (BAC). As the legacy asset servicing dwindles down and litigation expenses come down-- they have to some day; the true earning potential of this giant bank will be evident. I believe that the intrinsic value of this bank is somewhere in the mid 20s.
2. The other large position is own is Markel Insurance (MKL). I view this as a core position that I add to as opportunities present themselves. In 2013 I was able to add significantly to this position in October.
3. Another core position I am slowly building is Fairfax Financial (FFH). This business is quite similar to Markel and is run by a long term oriented able management. Fairfax hasn't had a good 2013 as they were quite bearish and hedged all their investment gains going into the year. I believe they are currently quite undervalued but as the market runs up, they may get even cheaper.
4. The only new position I started in 2013, was Fortress Paper (FTP). This is a hidden asset play that I posted about. It is hard to estimate intrinsic value of this business because of a number of unknowns at this point. This uncertainty and a string of bad luck has caused this stock to drop to all time lows, while the book value stayed quite stable.
5. The last position worth mentioning is cash. This position isn't due to some top-down call, but due to lack of new ideas and maturing of older ideas. This position earns barely anything in the money market, but provides large optionality if and when the markets present opportunities in the future.

2013 Performance and other thoughts

2013 has been a good year. As published on the historical performance page, the portfolio increased in value by about 36%. This was a little bit better than almost 32% the S&P500 market produced for the year-- which is stellar return for the market any year.

I am not too concerned with relative performance, but rather absolute performance. In either case, 2013 was an excellent year.

The portfolio was able to produce these results with minimal volatility and far less downside risk than the market itself. Throughout the year, the portfolio averaged around 40-60% cash, thereby reducing volatility. Cash also provided ample opportunity to start an new position or increase weighting of present positions as opportunities presented themselves.

From an opportunity cost perspective, if the portfolio was fully invested into positions from a year ago, the portfolio would have produced returns of close to 60%.

Hindsight is always 20-20.

As mentioned in the post at the beginning of 2013, I started selling out of positions as they approached my estimates of intrinsic value. It turns out that these stocks (Canam and Cisco, specifically) not only approached my estimate, but also surpassed it.

I knowingly "left money at the table". Evidently, I left a lot of money on the table!

I have no regrets. That would be the wrong lesson to draw.

Outlook

I remain concerned about the fundamentals of the economy and consequently the businesses. The top line numbers have practically stagnated, and the profit margins are at all time highs. Furthermore, the EPS keeps on going up thanks to large stock buyback programs. Market loves rising EPS numbers, and bids up the price of the stock. And since many companies needs to beat EPS estimates, they buy more of this ever expensive stock instead of investing into their own businesses.

This is a value destroying cycle that will end someday.

 As for 2014, as usual, I have no idea what the market would do. And neither does anyone else. All we can do is prepare for the opportunities that arise and be nimble if and when the seas get rough.

New position: Fortress Paper

Recently, when looking at the 52 week low list, I was surprised to see Fortress paper (FTP). The last time I came across this business, it was a high flying stock in 2011.

Fortress has had the worst set of luck lately. Their news release page is a great way to get a sense of the timeline of events. While the series of unfortunate events continue, the management remains highly resourceful.

Without going into the very interesting history of this business, let me get right to some numbers.

The book value per share is about $24.50 (Q3 2013), while the stock last closed below $4. The price to book ratio is 0.16. Market is assuming that the book value is going to be severely impacted as the business bleeds cash while waiting for dissolving pulp prices to recover. Market is probably right, but where I disagree is in the degree of the expected loss.

Mr market is very focused on the Canadian dissolving pulp business and seems to be ignoring their Swiss banknotes business.

It must be noted that majority of the assets on the book are locked up in property, plant and equipment; which is hard to unlock, but it is also far less likely to be squandered, unlike cash.

To determine a margin of safety, I performed a private market value analysis of the banknote subsidiary. This business now has a positive EBITDA and has tangible assets marked on the balance sheet at a discount. Furthermore, the intangibles of this business aren't on the balance sheet since they have been developed internally. Intangibles such as patents and customer relationships are incredibly large for this currency printing business. For example, this business is the sole producer of swiss francs in the world. They also print Euros for 10 countries. They own much of the technology behind the security features that are prevalent on modern banknotes.

Even if I assign $0 to the intangibles, I estimate a very conservative $150m for this business.

Now, on to the Canadian dissolving paper mills.

Let us assume an orderly liquidation of their dissolving pulp mills. I assign $100m for Thurso mill and $0 for LSQ mill. On the books there is over $300m of PP&E at these two locations.

Add in cash of $102m and pay down all debt of $227m, and we are left with $125M or 8.59/shr.

Last closing price was $3.9/shr.

Market is saying that this business is worth more dead than alive!

Not that I wish for fortress to liquidate all assets, I know something wonderful can happen if a living business is purchased at half the price of its liquidation value (which is a worst case scenario).

Disclosure: I am an owner of Fortress paper at the time of this post

Market observations -- mid 2013

As the number of undervalued securities disappear from the US market, I can't help but observe Mr Market's antics. This isn't to trade but rather for enjoyment.

Recently when the federal reserve announced possibly reducing the pace of quantitative easing, Mr Market had a small convulsion. The impact to the equity market is well known, however I find the impact to two other markets the most intriguing.

The long treasury bond dropped in price, raising the yield. Supposedly, this response is because Mr Market expects higher inflation in the near future. However, in a classic schizophrenic fashion, the price of gold also dropped significantly, implying expectation of deflation!

Only one these two avenues must be the right one.

For those who are so inclined could investigate the economic fundamentals and determine which of these are more likely in the near future-- deflation or inflation.

In either case, insurance to protect from either of these scenarios is available for cheaper than it recently was! Gold is the classic inflation insurance; while US treasuries are the deflation insurance of choice.

Disclosure: no position.

iWent

It is incredibly rare for me that a thesis pans out within a year. In the case of iGo, it only took about 3 months.

I initiated a position in iGo at half of tangible book and below 2/3 of net current asset value. My primary motivation was the very large margin of safety being offered by Mr Market for this loss producing business.

It paid off.

On July 11, there was a tender offer announced for 44% of iGo. The premium was 71% above the day's closing price. The stock promptly started to trade high next day and I started selling into it.

Why didn't I wait to tender my units?

The complexity of the deal and other factors compelled me to sell early. The biggest holder of iGo, Adage, has offered their units for tender. This doesn't leave much room for the rest of us. Also, the business has had further impairments and will likely release a horrible Q2 report. This information was buried  in their 8-k disclosure.

I sold because I didn't want to be holding a business with significantly small margin of safety.

54% return over 3 months isn't too bad at all either.

Full Disclosure: no position in iGo at the time of this writing

Going for iGO

One of the perverse effects of being a value investor is having a portfolio full of "uglies"!

As the market price of a stock rises (and starts to look beautiful to the lay person), a value investor sells it. He then uses those proceeds to purchase another "ugly" name.

This means that at any given moment, a snapshot of a value oriented portfolio will have nothing but mostly ugly names. Hopefully, if the manager does their homework well, these uglies will have been purchased at lovely prices. That is, lovely to a value investor.

This brings me to a recent position that I have initiated in the portfolio. I came across iGO Inc. (NASDAQ:IGOI) from Saj's blog. iGO's stock price has been quite ugly over the last year-- it has lost ~77% of its value.

But let us look under the surface.

Starting from the balance sheet, I see the book value at 7.26/shr with no debt outstanding. Net current asset value (NCAV) is 6.69/shr. The liquidation value of the business is about 4.86/shr.

The price at the time of this writing is 2.28/shr, which is 53% discount to liquidation value or 66% discount to NCAV. This is a very large margin of safety being offered by Mr. Market.

Looking at the income statement it is quite obvious why this business must sell at a discount to book. They have negative net income and free cash flow over last couple years.

My investment thesis is that over the next year, this business will, at the very least, slow the cash burn rate. Even a rate reduction will be enough to make this stock sell close to the NCAV; which is a reasonable value for a chronic loss making business.


Full Disclosure: I am an owner of iGO at the time of this writing.