Posts tagged THO

Fourth Quarter 2012 Client Letter

The end of any year is typically filled with reflection and resolutions.  We reflect back on the past year and what we did well and what we did not so well.  It’s a time for self-examination, and out of this grows the resolutions – to lose weight, get in shape, travel more, work less, earn more, say “I love you” to the ones you care about more often.

When we look back over this past year, we were a bit taken aback at how much fear there was in the markets.  If you think back over the past year, the year started with fears about Greece defaulting on debt leading to the Euro zone falling apart and a potential global recession.  This gave way to Spanish banks nearly failing.  Next was a fear that China’s powerful economy would slow such that growth around the world would stall.  Here at home we faced a vitriolic Presidential election that stirred fears on both sides of the debate.  In the wake of the election that, in the end really didn’t change the face of politics in Washington D.C. all that much, we ended the year facing a fiscal cliff and the fear that taxes would dramatically increase for everyone and that, once again, we would face a severe recession.

In spite of these fears, stocks climbed for the year with the S&P closing over 13% higher and the Dow Jones Industrial Average gaining just over 7% for the year.  Here at Aerie we didn’t perform as well as the broad indexes as we chose to remain more cautious in the face of some of these crises and fears.  We kept a higher allocation to both fixed income and cash for the year, which ended up a drag on our performance.  We also had a couple of trades that went bad for us.

Fear about market volatility – and an anticipation of stock prices falling more than they did – caused us to miss out on a couple of trades that we perhaps should have entered.  We twice attempted to purchase RV maker Thor Industries (THO) for around $30 per share using an options strategy we have used successfully in the past.  While we didn’t succeed in purchasing Thor – a shame, too, as the stock ran from the low $30’s to just over $40 per share – we still made a tidy profit on our trades, earning a combined return of 17.4% on an annualized basis on our two options trades.  We also attempted to purchase Timken Industries (TKR) for $35 per share, but were denied the chance when it was revealed that an activist hedge fund took a large stake in the company, driving up the share price.  Nevertheless, we still earned a good return from our options strategy there with return of 14% on an annualized basis.

One new tactic we have undertaken recently across many client accounts has been a strategy of selling options on stock indexes.  This particular strategy, which can take advantage of fear, is normally a good way to earn some extra income as long as the trade does not go too terribly wrong.  In order to control our risks, we predefine the total risk we are willing to take.  In November, in the wake of the election, fear over the fiscal cliff battle ramped up dramatically.  This was compounded when tensions heated up in the Middle East caused by Palestinian forces firing rockets at Israel.  The fear of a major Middle East conflict caused the stock market to tumble and we were unable to close out of our option position prior to the market meltdown.  With our risk defined, we didn’t stress too much, but this one loss did hurt a bit.  In the absence of this one trade, we would have had a very good year.  On a more positive note, we did manage to recoup 20% of our November losses in December with another similar trade as fears subsided and calm returned to the markets.

There were two changes to our holdings during this quarter.  The first was the elimination of Hewlett-Packard.  We addressed more completely the reasons behind our selling out of this stock here:  http://www.aeriecapitalmgmt.com/2012/10/22/packing-it-in-on-hewlett-packard/.  In a nutshell, we sold because management does not seem to understand where the value in the company actually lies and we have no hope they will discover that any time soon.  This stock is, in our opinion, a “value trap”.  That is, it appears to be a great company with tremendous potential, selling at a deep discount to its intrinsic value.  In reality, management seems to have no clue how to unlock the value at the firm which will cause the company to underperform for the foreseeable future – or, at least, that is our fear.

The second change was selling out of most of our Johnson & Johnson (NYSE: JNJ) position.  This has been a good stock for us, but we do have some concerns going forward.  The largest concern is a lawsuit the company has already lost in one state court and yet has not bothered to recognize in their financial statements.  Management seems to believe the loss will be overturned on appeal.  While this may indeed happen, this is very bad management.  It’s akin to getting a water bill for $2,500 for the month and thinking “I’ll just ignore this because there is no way it can be right and will surely be tossed out when I appeal it.”  It may be, but it could be you have a leak and the bill is correct, so the prudent thing to do is to budget for this contingency.

Looking ahead, we are going to continue to look for opportunities to buy good companies at great prices.  We will continue to seek out opportunities to enhance value, whether through option strategies or finding contrarian reasons to buy good companies.  We will continue to focus on cash flows – both at the company level and in returns on our investments.  As always, we recognize that you have lots of options available to you, and we want to thank you for the trust you have placed in us with a portion of your assets.

 

Alan R. Myers, CFA

President / Senior Portfolio Manager

Aerie Capital Management, LLC

(410) 864-8746

(866) 857-4095

www.aeriecapitalmgmt.com

Third Quarter 2012 Client Letter

There’s an old saw on Wall Street that markets climb a wall of worry and this past quarter proves it to be true.  This seemed to be the ruling thought for this past quarter.  Just to refresh your memory, over the past three months, we saw more unrest in the Middle East which caused oil to spike from below $80 per barrel at the end of June to just over $100 in early September before retreating a bit to close just over $90 per barrel.  We had to endure both the Republican and Democratic national conventions where we learned absolutely nothing new about either of the now official presidential candidates.  Mitt Romney promised to tell us after the election what his plans are and President Obama promised us more of the same.  The unemployment rate finally ticked down ever so slightly to 8.1%, but part of this was due to the number of people actively looking for work dropping slightly.  We saw continued unrest across Europe with demonstrations in Greece against the new government’s austerity measures and the need for a $60 billion bailout of Spanish banks (hey, that’s much better than the $100 billion that many had expected!).  Oh, and if that all weren’t enough, there is still the potential for the U.S. to drive off the fiscal cliff later this year (you can read more about this issue in my recent blog here:  http://www.aeriecapitalmgmt.com/2012/09/14/setting-sail-with-the-qe3/ ).

In addition to these larger macro issues, there were more stock specific issues that we faced during the quarter.  First, we had 82 companies in the S&P 500 Index that guided expectations for third quarter earnings lower versus only 21 companies that raised expectations for this quarter’s earnings.  This was compounded by the overall expectation that earnings for all of the S&P 500 Index companies will fall 2.7% versus the same quarter last year.

So, with all of this negativity and worry, there was quite a wall for the markets to climb and climb they did.  The S&P 500 Index rose 5.76% for the quarter while the Dow Jones Industrial Average only rose 4.32% for the quarter.  We here at Aerie will be the first to tell you that we underperformed the indexes for the quarter and we aren’t ashamed of that fact.  In fact, if things keep going the way they are, we may continue to underperform in the short term.  You see, we view our role as two-fold.  We have a responsibility to earn fair rewards for our clients, but we also have a role to mitigate risk.  It is this last aspect that drove us this past quarter and continues to dominate.  This past quarter was one in which we “took money off the table”.  In other words, as the markets continued their inexorable climb, we sold stocks that we felt had become fairly valued or even a bit overvalued.  We have raised cash in client accounts to an average of 30% across all accounts.  For some clients, we have more cash than for others, depending upon their unique situation.

As we said in our blog in September, we are seeing “inflation” not in commodities but in stocks.  With all of the money being infused into our economy by the Federal Reserve, it has to go somewhere, and that somewhere, at the moment, is into the stock market.  We are especially worried about possible price inflation on stocks that pay dividends, as it seems that investors may be chasing after yield.  It’s still possible to find stocks with high yields, such as many pharmaceutical companies.  However, many of the stocks with high dividend yields come with even higher risks.  Many of the drug companies, for example, are facing a massive loss of patents in the near future and have a large revenue stream to replace.  This could potentially lead to large dividend cuts which would severely impact the price of the stocks.  We’re just not willing to take that type of risk with our clients’ money.

We are not sitting idle, though.  We have been busy pulling together a “buy list” of stocks that we really want to own across client accounts.  We have even earned some money in many client accounts with at least one of these names.  One security that you may have seen in your account is an option on Thor Industries (ticker:  THO).  We sold a put option – an option that would obligate us to purchase this stock if the price fell below the agreed upon exercise price at expiration.  We have actually done this twice – the first time, earning almost 2% over a twenty-four day period (annualized rate of return of 31.32%) and the second time earning a more modest 8.1% annualized rate of return.  We are still obligated to buy Thor Industries – a maker of RV’s and campers – for $30 per share, but we feel this is a more than fair price to pay.

We have also begun a strategy to “hedge” client accounts by putting money into accounts.  We have been using a technique that involves either the Dow Jones index options or S&P 500 index options.  The technique we have been using is to find a point we think is a “bottom” for the market.  This has been made somewhat easier for us by the Federal Reserve’s quantitative easing program.  This has effectively put a “floor” under the markets – even if it’s just in the mind of traders.  We have then sold options while buying lower costing options that effectively limit our losses in case something goes wrong.  We collect the difference in premiums – cash that is going directly into accounts.  We are working on rolling this out to as many clients as possible as quickly as possible.  We feel this additional tool in our investment tool kit can provide a cushion against severe losses while providing us with additional funds for new investments over time.

As always, we do truly appreciate the trust that you have placed in us with a portion of your assets.  If you have any questions or need to discuss any issues, please feel free to give us a call.

Sincerely,

Alan R. Myers, CFA
President / Senior Portfolio Manager

Aerie Capital Management, LLC

(410) 864-8746

(866) 857-4095

www.aeriecapitalmgmt.com