Q2 2024 Investor Letter
Fellow Investors,
We’ve completed ten quarters since the launch of Kingdom Capital Advisors. A short time by investment measures, but an exciting time, nevertheless. Our primary benchmark, the Russell 2000 TR, is basically flat since KCA’s inception as “small cap” stocks struggle to garner interest. Meanwhile, the S&P 500 and the NASDAQ continue to mint new all-time highs on the backs of “mega-cap” technology stocks. Despite investors’ lack of interest in our chosen corner of the market and the relative underperformance of “small cap” stocks, we’ve managed to outpace the major US indices since January 2022. This brief measurement period has provided some initial validation for our stock-picking strategy, and we eagerly await an investing environment where “small caps” experience relative strength.
Kingdom Capital Advisors (KCA Value Composite) returned 5.40% (net of fees) in the second quarter, vs. -3.28% for the Russell 2000 TR, 4.28% for the S&P 500 TR, and 8.05% for the NASDAQ 100 TR.
Q2 felt like déjà vu, and to borrow from our last letter it “ended on a high note but felt like a slog.” Regis Corporation was one of our largest detractors in the first quarter and continued to decline throughout Q2. However, the Company refinanced their debt during the last week of June, sending the stock up ~300% in a day. The refinancing deal erased nearly $100m of debt with minimal dilution, a coup for investors. Despite the significant increase, the stock appears underpriced given the terms of the refinancing. The Company’s market cap only increased about a third of the amount forgiven by lenders, and a clearer path exists to paying down debt.
Our top contributors to Q1 returns were Regis Corporation (RGS) and Entravision (EVC), while Hanesbrands (HBI) and Abacus Life warrants (ABLLW) were our largest detractors.
Positioning Updates
We first mentioned Net Lease Office Properties (NLOP) in our Q4 letter, but I think it’s important to elaborate as we continue adding to our top position. As a quick refresher, NLOP is actively liquidating their portfolio of office buildings. There were two risks that stood out when we first invested:
Sales would take longer than expected
Realized sale prices would disappoint
Fortunately, sales have progressed at a rapid pace allowing NLOP to substantially reduce their debt. Once the debt is fully retired, we expect regular and special distributions will be a catalyst for re-rating shares. The situation is reminiscent of a favorite investment to date, Unit Corporation (UNTC). Like UNTC, I expect current investors to recoup their investment via dividends as soon as 2025, significantly de-risking the opportunity cost.
To date, realized prices have generally met or exceeded my estimates, with two notable disappointments from European holdings. However, the European holdings only represent 5 of the initial 59 buildings in the portfolio. Furthermore, as more sales are finalized, our margin of safety continues to widen. To this end, NLOP has approximately a $400m market cap and $150m of net pooled debt remaining. I think it’s possible to cover much of the enterprise value ($550m) with the sales of just 5 of their 47 remaining properties (KBR, PPD, CVS, Omincom, and Google). I’m surprised the market has not reacted more optimistically, but I am simply taking the lack of price appreciation as an opportunity to buy more.
The Regis refinancing provided a tremendous return during Q2, and we are eagerly awaiting a refinancing solution for Superior Industries (SUP). I continue to believe SUP has more upside than Regis, but the market is waiting for the situation to simplify.
Consider:
Superior is on track to exit the year earning about $190m of EBITDA, having optimized their European production by consolidating German operations in Poland. However, due to bankrupting their German subsidiary to make this move, its sales were temporarily removed from their financials and will “reappear” this year. I suspect the market hasn’t grasped this nuance, or the significant margin improvements resulting from this transition.
Superior has three main obligations which interact; their credit facility with Oaktree, publicly traded Senior Notes, and convertible preferred stock with TPG. The company has been opaque about their refinancing approach, which could encompass any part of the capital structure, but prioritizes the Notes coming due next summer. Superior has enough cash to mostly cover the redemption of the Notes, but I suspect a more sweeping change to the capital structure. Overall, I expect Superior to carry about $650m of net debt at a blended 10-12% rate at the conclusion of the process.
Therefore, we expect Superior to exit 2024 with the ability to repay $50-75m of debt per year, resulting in about 50% free cash flow yield on shares. While some auto suppliers face risks from the forecasted rate of EV adoption, Superior will not face obsolescence risk until cars no longer require wheels. We also see Superior positioned well for the “near-shoring” trend brought about by Covid, given their proximity to U.S. and European automakers. As the debt situation is de-risked, I expect Superior to trade around 5x EBITDA like most similarly situated producers. If the company achieves their stated goal of $240m 2027 EBITDA, along with expected deleveraging, the stock should trade above $20/share by 2027, over a 600% gain. This is a “show me” story, and we expect the market will require definitive news before a rerating can occur.
Looking Back
Since this is our tenth letter, I wanted to share a few fun moments since we founded KCA:
While attending last year’s MicroCap Club Conference in Chicago, we snagged some nice seats at Wrigley Field after a long rain delay (we’re value investors at our core). Naturally, my Pirates were visiting, and I had the all-too-familiar pleasure of watching them lose.
I was invited to the University of Texas to speak at their annual stock pitch competition and judge some stock pitches. We were thoroughly impressed by the work of participating students from universities across the country.
Mike completed the first (and possibly last) marathon in KCA history, having never run regularly in his life before 2023.
Business Update
We continue to grow our assets under management and welcomed fifteen new clients in the second quarter. We are extremely grateful to those that have referred potential investors.
On an administrative note, we had two positions move from OTC markets to the “Expert Market” in Q2. This can result in stocks not receiving quotations for periods of time and being quoted as worthless. We are exploring best practices on how to handle reporting around these stocks going forward and will keep you posted. Together, they represent about 2% of the total value of the KCA portfolio.
Thank you for trusting us to steward your funds wisely. As always, reach out with any questions.
Sincerely,
David Bastian
Chief Investment Officer
DISCLOSURES
This document is not an offer to invest with Kingdom Capital Advisors, LLC (“KCA” or the “firm”).
The statements of the investment objectives are statements of objectives only. They are not projections of expected performance nor guarantees of anticipated investment results. Actual performance and results may vary substantially from the stated objectives. Performance returns are calculated by Morningstar.
An investment with the firm involves a high degree of risk and is suitable only for sophisticated investors. Investors should be prepared to suffer losses of their entire investments.
Certain information contained in this document constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “intend,” “continue” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of the firm described herein may differ materially from those reflected or contemplated in such forward-looking statements.
This document and information contained herein reflects various assumptions, opinions, and projections of Kingdom Capital Advisors, LLC (“Kingdom Capital Advisors” or “KCA”) which is subject to change at any time. KCA does not represent that any opinion or projection will be realized.
The analyses, conclusions, and opinions presented in this document are the views of KCA and not those of any third party. The analyses and conclusions of KCA contained in this document are based on publicly available information. KCA recognizes there may be public or non-public information available that could lead others, including the companies discussed herein, to disagree with KCA’s analyses, conclusions, and opinions.
Upon request, KCA will furnish a list of all prior securities discussed in our publications within the past twelve months to include the name of each security discussed, the date and nature of each discussion, the market price at that time, the price at which the KCA acted upon the discussion (if at all), and the most recently available market price of each security.
Funds managed by KCA may have an investment in the companies discussed in this document. It is possible that KCA may change its opinion regarding the companies at any time for any or no reason. KCA may buy, sell, sell short, cover, change the form of its investment, or completely exit from its investment in the companies at any time for any or no reason. KCA hereby disclaims any duty to provide updates or changes to the analyses contained herein including, without limitation, the manner or type of any KCA investment.
Positions reflected in this letter do not represent all of the positions held, purchased, and/or sold, and may represent a small percentage of holdings and/or activity.
The S&P 500 TR, Russell 2000 TR, and NASDAQ 100 TR are indices of US equities. They are included for information purposes only and may not be representative of the type of investments made by the firm. The firm’s investments differ materially from these indices. The firm is concentrated in a small number of positions while the indices are diversified. The firm return data provided is unaudited and subject to revision.
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