I hope you had a nice holiday season. I thought I'd start the year by sharing my Q4 letter. Please see our disclaimers. The version below is edited for length and omits a few names discussed in the original.
Fourth Quarter 2019
January 2, 2020
Dear Partners,
I’m happy to report the results of our first year. Our partnership enjoyed at 12.43% net return for 2019 (subject to final audit). Your return will be different depending on when you invested.
This performance is good; especially considering we started our portfolio from scratch and it took me some time to get the cash invested. (As recently as September 30, we still had 20% in cash). If I could lock in a 12.43% return every year for the next 30 years, I’d take it.
You also have to consider the risks taken when evaluating any return. I am pleased to say we generated that return by staying with high quality, lower risk assets. As you know, I like to use the acronym CODE to describe what we’re looking for: Cheap (undervalued), Owner-operators (skin in the game), Disclosures (easy to follow) and an Excellent financial condition. I believe I stuck to CODE in building our portfolio in 2019 as you’ll see in the discussion below.
In the second half of the year, in particular, we were able to add five excellent businesses to our portfolio that meet our CODE. I will tell you about these in what follows. But first a look at our partnership…
The Financial Health of Our Partnership
We finished the year with twelve partners, excluding the Bonner family and myself. We ended the year with about $43.8 million in assets under management. Bill and I have decided to close the fund to new investors once we reach $100 million.
The business finished the year in the black. I have a good handle on our expenses – I run Woodlock House out of my home office – and I have all the resources to do what I need to do in terms of travel, research, etc. I have a great network, developed over many years, from which I draw a rich stream of ideas and hard-to-get insights. Woodlock House punches well above its weight here.
We also concluded a full-year with our service providers, NAV Consulting and Interactive Brokers. And I’m satisfied with the work they did for us in 2019.
As for me, I really enjoy managing the fund and I can see why so many investors continue to run money well into their advanced years. It’s a lot of fun and never boring! There are always new ideas to research, new things to learn and the investment landscape is always changing. Thank you for investing in Woodlock House and making it all possible.
With that, let’s get to a review of the portfolio…
Portfolio Overview
As you know, Woodlock House can range over the globe in search of opportunities. And we have taken advantage of that freedom to create a distinct portfolio. Only about 35% of our assets are in US-listed stocks.
We have fifteen positions. The top five stocks make up about 42% of the portfolio. All of these five stocks were large positions when we started in January – Howard Hughes Corp. (HHC), Exor (EXO.MI), Bolloré (BOL.PA), Fairfax Financial (FFH.TSX) and Fairfax India (FIH-U.TSX).
I significantly reduced our exposure to Air Lease (AL). We bought Air Lease initially at $33 per share – a deep discount to book value of $48 per share. Today, that valuation gap has closed. The stock was up about 45% for us in 2019. Since it is no longer as compelling, I cut its weight in our portfolio by half from roughly 11% to 5.5%.
With AL, we successfully took advantage of a wide gap between price and value. But ideally we wouldn’t own businesses like AL. It is very capital intensive, earns single-digit returns on its assets and is reliant on debt to finance new aircraft and grow.
Granted, AL does this safely by securing long-term leasing contracts for these aircraft and manages a mid-teens return on equity. The point I want to make, however, is that AL is a capital guzzler compared to the other businesses profiled in this letter. Over a longer period of time, such businesses generally do not perform as well as capital-light businesses that generate more free cash flow and earn far higher returns on their assets.
Of course, I am not complaining. Air Lease contributed mightily to performance this year. Should such an easy lay-up present itself again, I would take advantage of it. But again, ideally we would focus our capital on really outstanding businesses that we can hold for a long time – which lowers turnover, reduces taxes and enhances our returns – and not simply stocks where we are waiting for a valuation gap to close to make our exit.
A Reflection on Portfolio Turnover
This gets me to one important evolution I want to share with you, something that would’ve surprised me if you told me this in January last year.
I started with the idea of running a low turnover portfolio, one where we held on to most of our stocks for a long time. But I wound up selling a lot more positions than I thought I would.
In my view, turnover is generally indicative of mistakes. And I did make mistakes. But most of the turnover was strategic: As the year wore on, I narrowed the range of businesses I want to own.
We only need about a dozen good ideas. So we don’t need to be in deeply cyclical businesses or leveraged financials or other lesser quality businesses. We can keep the bar really high. Throughout the year, I kept finding great businesses I wanted to own go on sale now and then... so, I grabbed them. As a result, most of the turnover was “good turnover” in that I upgraded the quality of assets we own. I would expect turnover to decline as this process plays out and the portfolio matures.
But What About “The Market”?
Most managers feel obligated to say something about “the market” in their letters. I will not do this for a couple of reasons.
First, because I believe we’re better off focusing on “knowable things.” About 25 years ago, I read a thin book titled The Craft of Investing by John Train. There is a passage he wrote that I still remember. The pages of my copy are yellowing around the edges with age, but I found the passage that sticks in my mind and I want to share it with you here:
“Investment, as distinct from speculation, is the craft of the specific. It is extraordinary how much time the public spends on the unknowable. Is the market going up or down? Is the economy recovering? What is the government going to do?
“You should forget about the short term and not worry about the economy or the direction of the market. Instead, buy a share of a company the way you would buy a house: because you know all about it and want to own it for a long time at that price.” [Italics in the original.]
Train uses an analogy from military history. He says amateurs talk about grand strategy, but generals talk about supply lines and communication. In investing, the parallel is clear: wise investors focus on specifics – people, control, assets, how businesses are financed, priced, etc. Knowable things.
Second, you’ll notice I put the term “the market” in quotes. That is because there are many markets with many differences among them. There is the US-listed market and there are markets in other countries. And there are many differences within those markets. Even at the level of an index, say the S&P500, there is quite a bit of variation within it.
I’ve spent too much time with the works and ideas of the philosopher Alfred Korzybski to get worked up about big abstractions like “the market” “the economy” and so on. (I wrote a whole book applying his ideas, How Do You Know?) It is hard to talk about abstractions like these in meaningful ways, but easy to deceive yourself and think that you are. I try to work with fewer abstractions and keep things closer to lived experience.
However, all this doesn’t mean I don’t pay attention to ever-shifting big picture trends and new developments. As you know, I write an occasional blog. I write about my travels (to NYC, Toronto, Omaha, Switzerland, etc.), reading, research, stocks we own, and investing insights I uncover along the way.
My big picture views come out in those blog posts. A couple of the more important of these I wrote in December. I won’t repeat all what I wrote here, but simply refer you to the blog.
In 2019, I wrote 47 blog posts. You can find them all here:
Twitter is another place where I post notes that I find interesting or important. You can find my Twitter page here (and you don’t need to have a Twitter account to see the content there): @chriswmayer
In all of this work, you can see there are always opportunities. Again, we only need about a dozen good ideas in a universe of over 10,000 listed stocks. All is to say that even after a strong year for the S&P500, I am finding plenty of ideas for us. (And when I don’t, I’m happy to hold cash).
Now, let’s look at the new businesses we acquired in the second half of the year
InterContinental Hotel Group (IHG.LSE)
Cheap: High quality business acquired at a 5% free cash flow yield (and growing), nearly 20% off its high
Owner-operator: Management team owns little stock, but incentives are aligned and the company has a long-term culture of being shareholder friendly
Disclosures: Simple business to follow
Excellent financial condition: Investment grade balance sheet
IHG has a beautiful, asset-light business model. It primarily manages 5,600 hotels through management and franchise agreements. It does not seek to own hotels (though it currently owns about a dozen legacy hotels).
These agreements run for 20-30 years and have hefty termination fees. Importantly, IHG earns fees mostly based on revenue of the hotel it manages not profits. For franchises hotels (about 30% of its rooms), IHG earns fees based on revenue and partially on operating profit. This makes for a less cyclical business model than owning the hotels. Also, since IHG does not own the hotels, it is not responsible for the heavy capital spending owners incur.
The end result is a high-margin, cash generative business with returns in excess of 40% on its capital. Much of this excess cash flow comes back to shareholders. Since 2003, IHG has paid $13.6 billion through dividends and buybacks. For reference, the entire market capitalization of the company today is about $12 billion. Meanwhile, the stock is up 5x.
IHG has over 100 million loyalty members, second only to Marriott at 110 million. IHG includes a mix of brands (16) under its umbrella, but Holiday Inn and Holiday Inn Express make up about 60% of its rooms. These are at the “value” end of spectrum and should help IHG’s business hold up better during downturns than pricier hotels.
I usually stay at a Holiday Inn Express when I go to the Berkshire annual meeting in Omaha ever year. In fact, on my last trip to New York, I also stayed at a Holiday Inn. I always find the properties clean, well maintained and available at a good price. (Henceforth, of course, I will only stay at IHG properties!)
The company has an investment grade rating and is only lightly levered. So it checks that box for us. It is a simple business and one we can easily follow. So it checks that box too.
Management does not own a big percentage of stock, which is a negative for us. However, IHG has a long tradition of a being a shareholder friendly company. (I mentioned the return of free cash flow to shareholders above). The current CEO, Keith Barr, is the 4th CEO since 2003 and has been with IHG for over 20 years. He took the reins in 2017.
So far, he’s following the playbook laid out by his predecessors. And management has a fair long-term incentive plan that includes payouts based on shareholder return and cash flow.
IHG shares sold off from a summer high of £57 to a low of £45, a drop of over 20%. We built a position with an average cost of £47 per share. At that price, we were getting about a 5% free cash flow yield. That’s a fair price to pay for a business of this quality. As long as IHG does not stray from their playbook, this is one we may never sell.
Why the summer selloff? Some of it was due to bad news from China, where IHG has significant exposure (about 15% of rooms). And some of it was probably recessionary fear in the US. Revenue per available room (RevPAR) fell -0.2% in the first half of the year and was flat in Q3.
Cyclical risks are part of investing. But longer-term, IHG’s resilient business model should continue to deliver as in the past. China, too, represents an opportunity for IHG. The market is highly fragmented but growing rapidly. Marriott, IHG and Hilton are the leaders and all have large pipelines in China.
JD Wetherspoon (JDW:LSE)
Cheap: Strong performer acquired at a 6%, growing free cash flow yield
Owner-operator: Tim Martin owns 31% of the shares, excellent capital allocator
Disclosures: Simple business, excellent shareholder letters
Excellent financial condition: More levered than we’d prefer, but a very resilient business (see 2008 experience below).
I wrote about Wetherspoon on the blog. I have come to greatly admire what Tim Martin, the founder and CEO of Wetherspoon, has built.
Founded in 1979, Wetherspoon runs nearly 900 pubs in the UK. Martin focused on being a low-cost retailer with prices far below competitors. He has created a business with loyal customers and good ratings. It is also a business that generates a ton of cash and has been an excellent investment for its owners.
As Martin noted in his 2018 annual report (2019 is not yet in hand):
“Since our flotation in 1992, earnings per share before exceptional items have grown by an average of 15.4% per annum and free cash flow per share by an average of 15.5%.”
And the stock price? Up roughly 30x. In the last three years, it’s doubled. I wish I had bought it sooner. But I only learned about Wetherspoon over the summer and it took some time to do the research and get comfortable with the business. As it is, we have about a 5% position at an average price of £15.23. At the price, we’re getting a free cash flow yield of 6%+.
Return on equity has averaged 25%+ over the last decade. Martin likes to opportunistically buy back stock. The number of shares has fallen by 25% over the last decade. Longer-term, Wetherspoon’s cannibalism is even more impressive. In 2002, there were 214 million shares. Today, there are 105 million shares – a drop of over 50%. Since Martin doesn’t sell, his ownership in Wetherspoon has increased to over 30%. He’s a true owner-operator. Martin is 64 and should have plenty of years yet to run Wetherspoon.
Martin writes “Buffett-esque” letters, full of blunt talk. He even includes a section on “owner earnings,” which is one of Warren Buffett’s metrics used to get at the true earnings power of the business. Martin’s annual letters are like annual letters should be: a sober look at the important metrics of the business, written as if to a partner – not a slick marketing piece full of buzzwords.
Nothing is perfect, however. Wetherspoon has more debt than we’d normally like to see. It has more leverage than it appears when you add in lease obligations.
However, I am comfortable with it here because of Wetherspoon’s proven resilience. In the 2008 crisis, for example, it suffered a 17% decline in sales, but only an 8% decline in earnings. Most importantly, Wetherspoon still generated very healthy free cash flow numbers.
The stock ran away from me toward the end of the year, especially in the wake of the UK election results. Wetherspoon rallied 9% the day after the results. I would love to add to it should I get the chance in 2020. Otherwise, this is a steady consumer franchise that we should be able to own for years.
Next, Plc. (NXT:LSE)
Cheap: Acquireone of the UK’s top performers at nearly a 7% free cash flow yield
Owner-operator: Simon Wolfson, CEO, excellent capital allocator
Disclosures: Simple business, wonderful shareholder letters
Excellent financial condition: Investment grade balance sheet
Simon Wolfson, the CEO of Next, got the job at age of 33. That made him the youngest CEO ever to lead a UK blue chip company. He’s been on the job for 19 years now. Here is the Financial Times in January a year ago:
“[Wolfson’s] 18-year tenure on the job is now second only to Bronek Masojada’s 19 years at the helm of Hiscox, although unlike Next, the insurer has not been a FTSE 100 constituent throughout. The total return from Next shares since his appointment has been 775 per cent, thrashing that of the FTSE 100, the retail sector and key rivals such as Marks and Spencer.”
Wolfson is our owner-operator here. He owns over $100 million worth of stock, which is not a large percentage of Next’s $13 billion market cap, but it is a good chunk of change for Wolfson.
Next is a UK-based clothing retailer. And Wolfson has proven to be a smart strategic thinker. He has found a path for Next to navigate the challenges of retail.
Next has created its own thriving online business, not only of its own brands but as an online aggregator of other brands, too. In 2003, online made up about 23% of sales. Last year, for the first time, more than half of sales originated online. The business also has expanded beyond the UK. In 2003, 0% of sales came from non-UK markets. Last year, nearly 20% did.
Wolfson is also an excellent capital allocator, which is important because Next generates a lot of free cash flow. That capital allocation has helped overcome the decline in sales in its physical stores.
From January 2015 to the middle of 2018, Next returned £1.7bn to shareholders through special dividends (£685m) and share buybacks (£1.0bn). Meanwhile, earnings per share for the year ending January 2020 are likely to be the highest Next has ever delivered.
Next is another long-time cannibal of its shares. It has retired 30% of its stock over the last decade. This is a good business with returns on assets over 20% and strong free cash flow. We also have an investment grade balance sheet. And in Wolfson we have a top-notch capital allocator and business builder.
We bought shares at an average price of £59.75. A that price, we paid about 15x free cash flow for a 6.6% free cash flow yield. Again, this is a good price for a business of this quality. The shares didn’t stay there for long, though. They quickly ran away from us after the UK elections and we are up 20% on the stock already. I have a price in mind I would like to pay and I will add to Next should we get the opportunity.
Wolfson also writes excellent shareholder letters. He does a 15-year “stress test” in which he makes pessimistic assumptions to see what the business might look like over time. I won’t share all the details here, but I will share Wolfson’s conclusion:
“In summary, annual declines of -10% in like-for-like sales in our retail business, combined with CAGR of 7.5% in our online business looks likely to deliver cash generation of around £12 billion over the next fifteen years, with cash generation in the final year being in the order of £1.1 billion.”
That is tremendous for a company with a $13 billion market cap. And those assumptions seem pessimistic. Retail sales at their stores have not declined at that pace, and the online business has grown faster. Even so, the point of the exercise is to show the potential cash generation of this business, which the market only recently seemed to recognize.
Next is another one we should be able to sit on for a long time.
Texas Pacific Land Trust (TPL)
Cheap: Acquired at a discount of at least 20% to a growing net asset value
Owner-operator: Horizon Kinetics owns nearly one quarter of the shares
Disclosures: Improving as part of Horizon’s campaign
Excellent financial condition: Debt-free
Texas Pacific Land Trust has been one of the best performing stocks of the last 20 years, returning 17% annually. The Trust dates to 1888 and formed part of the land holdings of the old Texas & Pacific Railroad. It is the largest landowner in the state of Texas. And it was lucky to have its land in the heart of the Permian Basin in West Texas.
The Permian is one of the richest oil resources in the world. Nearly half of US oil production comes from the Permian. All the big players are at work here – especially Exxon, Chevron and Occidental.
TPL owns “non-participating perpetual royalty interests” (NPRIs) in about 460,000 acres. NPRIs entitle TPL to a perpetual right to receive a fixed cost-free percentage of production revenue. TPL also charges users for easements -- for pipelines, work crews, roadway rights, power lines, storage facilities, etc. Since its land covers such a large area, almost any infrastructure project will cross TPL land.
Finally, TPL controls the water rights to these acres. As drilling is water intensive, this creates an opportunity for TPL to charge for access to its aquifers and for water recycling. TLP created Texas Pacific Water Resources in 2017 to meet this demand.
TPL came on our radar after a near 30% decline from a high of ~$900 in April. I had been following the story casually through Horizon Kinetics, who owns about a quarter of the shares and is involved in a case against the trustees to convert TPL to a C corp. and improve disclosures and governance. (This seems to be going well. On December 4, TPL announced the case for converting to a C corp. was “compelling.”)
The company also continues to report strong results. I would highlight in particular the $32 earned per share (or unit) for 9 months. TPL is on pace to do $42 per share in earnings. At $650 per share, the stock trades for about 15x estimated 2019 earnings. This for a fast-growing company with a 66% net margin (for 9 months) and no debt… Using a variety of valuation methodologies, TPL is worth at least $900 per share and growing.
We picked up shares at an average cost of $645 and the stock is already 20% higher. TPL has a wonderful business model and earns high returns on its assets, exceeding 100%. It is a way to own real assets but by skimming off the cream.
TPL is another cannibal of its own shares. It’s retired 8.5% of its stock since 2014. With Horizon’s involvement, I expect future free cash flow will reduce the share count further.
A.O. Smith (AOS)
Cheap: Another high-performance stock, acquired nearly 30% off highs, a ~5% free cash flow yield
Owner-operator: Smith family owns 14% of the shares
Disclosures: No issues here, simple business
Excellent financial condition: Zero net debt
Lastly, we added A.O. Smith, a leading manufacturer of water heaters, boilers and filtration products. AOS has nearly 40% of the residential market in North America and over 50% of the commercial market. Founded in 1874, it’s another family owned firm. The Smith family owns about 14% of the stock. AOS is another excellent business generating returns on equity of 20%+ with zero net debt and strong free cash flows.
The stock has been a winner up almost 7x in the last decade. But it recently fell over 30% from its high and we built a small position near the lows with an average cost of about $47.
The reason for the selloff was a sharp decline in sales in China. Over the past ten years, business in China has increased at a 21% clip to over $1 billion in sales. It now makes up one-third of overall sales. That growth came to a halt in 2019 and the market bailed. AOS still has room to grow in China, though, and I would expect growth to resume at some point.
AO Smith has taken that same game plan to India, where water treatment needs are acute. Though small now, this could be another huge business for AOS in the future.
The business produces lots of free cash flow and I like AOS’s discipline in how they allocate that cash. They’ve returned cash to shareholders via buybacks and dividends. In fact, the dividend has increased at a 30% rate over the last 5 years. Meanwhile, the shares outstanding have shrunk by 8% during that time.
Conclusion – Looking Ahead to 2020
As for a roadmap ahead, I’d love to add to InterContinental, Wetherspoon, Next, Texas Pacific and AO Smith as the market permits. I will continue to look for new opportunities and ways to improve the asset quality (and return potential) in our portfolio even further.
We’ll get year-end results for our businesses soon. I’ll update you on their progress in Q1. In the meantime, please don’t hesitate to send me your questions and comments.
Thank you for your support and here’s to a profitable 2020 and beyond. I look forward to writing you again soon.
Sincerely,
Chris Mayer
Portfolio Manager & Co-founder
Disclaimer
This letter does not contain all the information that is material to a prospective investor in the Woodlock Family Capital, L.P. (the “Fund”).
Not an Offer – The information set forth in this letter is being made available to generally describe the philosophies of the Fund. The letter does not constitute an offer, solicitation, or recommendation to sell or an offer to buy any securities, investment products, or investment advisory services. Such an offer may only be made to accredited investors by means of delivery of a confidential private placement memorandum or other similar materials that contain a description of material terms relating to such investment. The information published and the opinions expressed herein are provided for informational purposes only.
Not Advice – Nothing contained herein constitutes financial, legal, tax, or other advice. The Fund makes no representation that the information and opinions expressed herein are accurate, complete, or current. The information contained herein is current as of the date hereof but may become outdated or change.
Risks – An investment in the Fund is speculative due to a variety of risks and considerations as detailed in the Confidential Private Placement Memorandum of the Fund, and this letter is qualified in its entirety by the more complete information contained therein and in the related subscription materials.
No Recommendation – The mention of or reference to specific companies, strategies or instruments in this letter should not be interpreted as a recommendation or opinion that you should make any purchase or sale or participate in any transaction.