Q1 2022 Investor Letter
Fellow Investors,
The first quarter of 2022 was marked by heightened volatility in the markets, and we expect this “choppiness” to continue. Lingering COVID fears, geopolitical tensions, and red-hot inflation have all played a role in shaking investor confidence and these issues are far from resolved. The Federal Reserve is attempting to thread a needle by curbing inflation without causing a recession, and we don’t care to speculate on their probability of success.
Despite this “macro” backdrop, we are pleased to report the KCA Value Composite returned 31.89% net of fees in the first quarter, vs negative returns across the major indices. We do not aggressively celebrate strong quarterly performance just as we would not overly bemoan weak quarterly performance. Investing is a marathon, not a sprint, and our fund is based on our belief that short term price movements are often inefficient.
Volatility in the market provides an opportunity for active management but capitalizing leads to increased short-term gains. A substantial percentage of gains in Q1 were realized short-term capital gains, partially due to successful pair trades and short-term hedging gains. We continue to hold nearly 80% of our assets in longer-term core positions and intend to capitalize on volatility with active hedges and smaller special situations when appropriate.
Strategy and Positioning
For a stock to be “mis-priced,” investors would need to be fundamentally wrong about the business, the stock would need a forced buyer or seller, or the stock would need to be underfollowed to the point that no one has recognized the dislocation between price and value despite new information. Stocks can be underfollowed for multiple reasons, but micro/small cap stocks are often underfollowed merely due to their size. Smaller stocks do not provide the liquidity necessary for larger institutional investors to take positions; therefore, why spend any time/resources analyzing these stocks? Entire industries can also fall out of favor and the corresponding stocks become underfollowed. Fossil fuel companies are a prime example where ESG (Environmental, Social, and Governance) mandates restrict investments. Searching in spaces where few investors are competing maximizes our opportunities.
We are significantly allocated in commodities due to what we perceive as global tightness from under-investment during COVID lockdowns, tightness in the labor markets, and low global stockpiles. The horrific conflict in Ukraine has further exacerbated shortages and we continue to believe the market is underpricing the impact this war will have on commodities in the coming years. Returns were strong in Q1, but we believe the fundamental business of these stocks improved more than their valuations during the quarter.
How could we be wrong? Further COVID lockdowns, increased global supply, reduced demand due to a global recession, and company-specific events could impact our holdings. We will continue trying to hedge these risks where appropriate and investing in stocks we believe can weather the future economic environment. Some reasons we feel comfortable with these risks:
DOLE, ARCH, and PDER each own most of their properties and have much less inflationary cost exposure than peers, leaving them well positioned in a variety of operating environments.
AMRK is perceived to be over-earning for the past few years but has historically performed best in bear markets and under inflationary conditions (hello 2022). We expect AMRK to report Q3 earnings per share around $5, versus Wall Street analyst estimates around $2.
The broader S&P is currently trading around a 2.2% free cash flow yield[1] (45 times the amount of expected cash available to shareholders), whereas most of our core holdings are trading above a 10% yield, some approaching 100%. With risks around cost inflation, reversals of globalization to onshoring, and rising interest rates, we are more focused on near term earnings power than the market has been for the past decade.
In summary, we continued to find undervalued stocks and expect to remain fully invested.
Portfolio Commentary
Below is brief update on a few of the positions in our current portfolio. Investors have complete transparency into all positions and are encouraged to contact us with specific questions at any time.
Unit Corporation (UNTC): UNTC emerged from bankruptcy after initial COVID lockdowns with a new management team and lenders as majority owners. To protect their tax benefits, an ownership limitation was put in place, capping acquisitions of shares at 4.9% without company authorization. An Oil & Gas producer with an ownership cap, recent bankruptcy filing, and no analyst coverage is the kind of stock many ignore. The company has minimal Investor Relations efforts and failed to issue a press release with their Q4 results, which was a shame given they earned almost $7/share! The company is repurchasing shares, marketing assets for sale, and generating a significant pile of cash, and all this good news has gone seemingly unnoticed.
Arch Resources (ARCH): We profiled ARCH on Seeking Alpha before their FY21 earnings release[2]. At the time, metallurgical coal pricing was near record highs, and we found shares significantly undervalued. Shares have increased 15% since our article was published but metallurgical coal pricing has roughly doubled. It may take months, not years, for ARCH to earn its entire valuation while selling coal near these prices. Meanwhile, ARCH remains a low-cost producer in the US and has articulated the clearest capital return plan of any major coal company we have studied.
Dole PLC (DOLE): DOLE finished the quarter roughly flat compared to our cost basis, despite what we believed to be great Q4 earnings and continued execution by Management. The stock trades at roughly half the value sought at IPO a year ago, and many prior risks have been mitigated. Inflationary costs and interest rates have been hedged, Management is showing good progress on integration, and recent salad recall issues are resolved. We are content to own the largest integrated producer of fruits and vegetables at an underwhelming valuation amid significant global uncertainty.
Pardee Resources (PDER): PDER owns over 160k acres of timberlands, over half a million acres of oil and gas rights, paid over $20 of dividends in FY21, and is on track to earn far more in FY22 with higher commodity prices. Management has consistently paid dividends, repurchased shares, and made strategic purchases; though a few poor acquisitions appear to have overly punished the stock. As a royalty business, their cost structure is almost completely fixed, leaving the upside for shareholders. Over the past 20 years, PDER has returned almost 10x on an investment, and is now in one of the most favorable operating environments in recent history.
A-Mark Precious Metals (AMRK) has been a favorite of ours since COVID began. The stock is up over 10x since early 2020 but remains remarkably cheap as they continue to demonstrate the earnings power of their enhanced platform. Acquiring JM Bullion and multiple metals mints have permanently improved the cost structure and earnings power at AMRK, with new offerings like Cyber Metals representing additional upside. We expect an announcement soon regarding international expansion, which is another anticipated tailwind given Management’s strong M&A execution to date.
Summary
We sincerely appreciate you entrusting us with your investment. Mike and I have invested the majority of our net worth in Kingdom Capital and will continue to steward your capital as we do our own.
We recently partnered with Advyzon for enhanced performance reporting capabilities. We will be reaching out to investors individually to provide access to the new client portal and mobile app.
We are continuing to onboard new investors and would appreciate any referrals you deem appropriate.
Sincerely,
David Bastian
Chief Investment Officer
[1] https://www.forbes.com/sites/greatspeculations/2022/04/11/sp-500--sectors-free-cash-flow-yield-rises-above-pre-pandemic-levels/?utm_source=dlvr.it&utm_medium=twitter&sh=72d2a1d02e17
[2] https://seekingalpha.com/article/4486974-arch-resources-stock-earnings-coal-boom-free-cash-flow
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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