Despite LL Call, Whitney Tilson Down 4.4% In June

Whitney R. Tilson’s Kase Capital declined 4.4% in June vs. -1.9% for the S&P 500. Year-to-date, the fund has declined by 3.2% compared to 1.2% for the S&P 500. In his second quarter letter to partners’ reviewed by ValueWalk, Whitney Tilson commented on this decline. Tilson remains confident in his thesis for each of the stocks for the fund. While a year-to-date decline of 3.2% is disappointing, only four months beforehand, during February, the fund gained 8.6% — things can turn very quickly when holding a concentrated portfolio.

During the quarter the fund’s best performers on the short side were Lumber Liquidators Holdings Inc (NYSE:LL) (-32.7%), TMF (-27.7%), Unilife (-46.4%) and World Acceptance (-15.6%). Short positions that didn’t play out as planned were, Exact Sciences and Herbalife Ltd. (NYSE:HLF), which gained 35.1% and 28.8% respectively.

On the long side, Kase Capital’s strongest performers during the quarter were Goldman Sachs Group Inc (NYSE:GS) (11.1%), magicJack (8.6%) and JetBlue (7.8%). Long positions that failed to yield results were, Micron Technology, down 30.6% during the quarter, Avis down 25.3%, American Airlines -24.3%, Spark Networks -24.0%, and Hertz -16.4%.

Whitney Tilson: Consolidating industries

Whitney Tilson uses some of his second quarter letter to discuss investing in consolidating industries. Four of Kase’s five largest positions are in the semiconductor, car rental and airline industries, four industries that have been historically characterized by cutthroat competition. However, recent industry consolidation has made these companies more attractive. A dramatic improvement in operating margins followed consolidation as these companies adjusted to the new oligopolistic situation.

That being said, investor pessimism, coupled with doubt questioning how much longer inflated profit margins will last, are two factors that have depressed multiples presenting an attractive opportunity for the shrewd investor.

Although, investors should be under no illusion, these companies have not gone from being bad to good overnight. They have gone, in Whitney Tilson’s words, from “being awful to okay”.

Tilson prefers to own long-term compounders, stocks Kase can buy and hold for many years; Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) is an example. Howard Hughes Corp (NYSE:HHC) and Platform Specialty Products are two other examples given.

Whitney Tilson goes on to discuss the cyclical stock trade. Specifically, most investors tend to trade cyclical stocks, rather than adopting a buy-and-hold approach. Some of Kase’s largest positions are cyclicals and when Tilson entered these positions it wasn’t for a quick trade, neither did he enter with the goal of holding them indefinitely. Whitney Tilson entered each position with a clear price target, the low end of his estimate of intrinsic value. Then Kase waited, prepared to sell, bank profits and move on.

Tilson has realized that it’s difficult to make money trading as a hedge fund, it’s not his specialty. Therefore, he sticks to the simple mantra of buying stocks when they’re very cheap and selling them when they reach the low end of his intrinsic value calculation.

“Very few people make money trading – and I know I can’t. I simply buy (or add to) stocks when they’re very cheap and start selling them when they reach the low end of intrinsic value – and otherwise I tend not to do anything at all. For example, I can’t recall the last time I traded a stock just before a quarterly earnings report. It’s just not a game at which I can be successful.

That said, I’m constantly collecting information, filtering out the noise (99% of it), testing my investment thesis for each position I hold, adjusting my estimates of intrinsic value, and buying or selling as appropriate.” — Whitney Tilson Q2 letter to investors.  

Whitney Tilson: Micron Technology

Micron Technology is Kase’s worst performing stock year-to-date. The fund is still in the black on the position since inception, but Micron is down 46% year-to-date. Micron manufactures semiconductors, primarily dynamic random access memory (DRAM) chips and NAND flash memory products. The DRAM industry has now consolidated to the point where three major players, Micron, Samsung Electronics Co., Ltd. (LON:BC94) (KRX:005930), and SK Hynix control over 90% of the market.

With improving fundamentals and tailwinds from an increasing demand for memory products, Whitney Tilson believes that the company can earn $4/share in the near-term.

“It’s hard to know when this will happen, however. I thought it might be as early as this year, but the company has encountered significant headwinds, which were reflected in a poor Q3 earnings report last week, in which the company also gave very weak guidance for Q4. As a result, the stock tumbled another 20%…” — Whitney Tilson Q2 letter to investors.  

Tilson notes that in an investment world where most investors are focused on near-term performance, Micron has fallen out of favor following one poor quarter. But for an investor with a multi-year time horizon, the company still offers value for money. At present levels, Tilson is considering adding to the position.

Whitney Tilson: Lumber Liquidators

Lumber Liquidators has been Kase’s best-performing stock year-to-date. The short is down 68.9% so far this year, and Tilson believes that it can fall further.

Whitney Tilson’s’ research shows that the company’s customers are deserting it in droves, and the company is being forced to slash prices. Falling sales, coupled with mounting legal costs will result in a far-worse-than-expected quarter that will trigger another leg down for the stock.

Lumber Liquidators is only four months into a 12-month turnaround according to Tilson. Lumber Liquidators is in a full-blown crisis, with the departure of four senior execs, investigations by a half dozen federal agencies and two US Senators. The stock trades at 49.1x this year’s earnings estimates and 14.2x next year’s estimates. These multiples are much too high for a business of mediocre quality that is facing enormous uncertainty and contingent liabilities that, in a worst-case scenario, could bankrupt it.

“I highly doubt that Lumber Liquidators will earn $1.45 next year, but even if it did, I think a 10x multiple would be generous, so that translates into a stock price of $14.50 – 30% below today’s levels.” — Whitney Tilson Q2 letter to investors.