What We're Reading ~ 10/7/15

Superforecasting: The Art and Science of Prediction [Philip Tetlock & Dan Gardner]

Fat tails, thin ice [Jason Zweig]

Are you prepared for the next bear market? [Fortune]

Most CFOs think the US market is overvalued [Alpha Architect]

Putting a price tag on the Volkswagen scandal [Aswath Damodaran]

A pitch on beaten down Sun Edison [Bronte Capital]

Case study on capital allocation and Rockwood Holdings [Before Losing My Sanity]

Do as they do: a guide to insider activity [Dead Companies Walking]

A look at Cable One [Punch Card Blog]

Some stock picks from François Rochon [Montreal Gazette]

How the Bloomberg terminal made history and stays relevant [FastCompany]

Sneaker wars: inside the battle between Nike and Adidas [GQ]

The decline of 'big soda' [NYTimes]

China's middle class dreams in peril [WSJ]

Can Comscore/Rentrak go toe-to-toe with Nielsen? [Variety]

Google Fiber's real innovation [Beyond Devices]

Why we fall for bogus research [Bloomberg View]

Alcoa and the painful business of making aluminum [Reuters]

The frustrating life of a McDonald's franchisee [Bloomberg]

What We're Reading ~ 6/24/15

A Wealth of Common Sense: Why Simplicity Trumps Complexity in Any Investment Plan 
[Ben Carlson]

The loneliness of the short-seller [NYTimes]

Shorters needed [FT Alphaville]

Fat tails, thin ice [Jason Zweig]

What is staying power? [Fundoo Professor]

On the fear premium in stocks [Crossing Wall Street]

A look at Brookfield Asset Management [Brooklyn Investor]

Mobile is eating the world [Andreessen Horowitz]

Sketching out the internet of things trendline [Brookings]

The way humans get electricity is about to change forever [Bloomberg]

Cheap energy poised to shake up pipeline industry [WSJ]

Driverless cars + Uber = death of car insurance? [Value & Opportunity]

Insurers cannot be asleep at the wheel [Bank Underground]

Buyback extravaganza [Investor Field Guide]

Beware the stock buyback craze [WSJ]

Union Pacific: the railroad with better profit margins than Google [Fortune]

Ant Financial valued at $45 billion after fundraising [FT]

The CFA vs MBA decision [A Wealth of Common Sense]

Best age to go to business school [Bloomberg]

East Coast on Transformation Investments: Union Pacific, Colfax & WABCO (Q4 Letter)

Christopher Begg's East Coast Asset Management is out with their Q4 letter.  Last time, we highlighted their letter on investment process and this time around, they focus on examples of 'transformations' that they invest in.

East Coast defines transformations as businesses that often have average or below-average economics and they are focused on seeking the cause that will produce a 'meaningful inflection point of change' on the economics of the business.

Begg writes,

"Our investment process becomes considerably more important when we try to ascertain if a business is truly transforming and emerging toward greatness.  Every business is either getting better or worse with change, and we feel the market tends to value businesses on a one-point perspective by inferring the status quo.  This can lead to mispricings for those transformations that we identify prior to change agents being reflected on businesses' financial statements."


3 Types of Transformations & Investment Examples

They've broken this down into 3 categories:

Secular:  Prolonged positive inflection point in a business' economics (often after industry consolidation).  Examples that East Coast owns include Union Pacific (UNP) and Burlington Northern Santa Fe (via Berkshire Hathaway ~ BRK.B)

Systemic: A business that adopts new companywide operational and cultural methods that drive change.  Ex: Colfax Corp (CFX), which East Coast purchased in the fourth quarter.

Separation: Often a result of spin-offs, these businesses weren't operating at full potential within the context of a larger organization.  Ex: WABCO (WBC), which they also purchased in Q4.


To read East Coast's thesis summary on each security, read their Q4 letter embedded below:

 


For more from this manager, head to East Coast's thoughts on what defines a great business and a look at IBM.

Children's Investment Fund on News Corp, Union Pacific & Walt Disney: Q2 Letter

The Children's Investment Fund manages approximately $4.7 billion and has returned 15.7% annualized.  Year to date through the end of the second quarter, they were up 16.39%. 

Founded by Christopher Cooper-Hohn, Children's has assembled quite a concentrated portfolio and we wanted to highlight some excerpts from their second quarter letter.

Children's Top 10 Positions as of Q2 

1. CESP: 18.2% of fund NAV
2. News Corp: 18.1%
3. Lloyds Bank Bonds: 17.9%
4. Japan Tobacco: 16.8%
5. QR National: 13%
6. Red Electrica: 9.7%
7. Porsche SE: 9.6%
8. Coal India: 8.6%
9. Walt Disney: 8%
10. Enagas: 7.3%


Railroads: QR National & Union Pacific

Children's owns QR National where the thesis has been focused on a transition from government-run entity to private company.  Management is focused on improving operating performance and achieving growth through investment. 

Children's expects the balance sheet to re-leverage over time, anticipating aggressive share buybacks (inclusive of any selling the government might do with its remaining 34% stake).  Of the stake, Hohn writes,

"With 7-8% normalised unlevered free cash flow yield, considerable volume and legacy contract re- pricing, we believe QR should compound at above 20% pa medium term returns. QR’s significant hard asset backing and very conservative balance sheet limit the downside of the investment. We believe the fair value of the asset is approaching double the current share price."

They also own a stake in Union Pacific (UNP) and while they see coal headwinds continuing there, they believe the company can grow EPS at 13% for the next several years and generate an IRR of 15%. 


On News Corp

Given that News Corp is one of their largest positions and many other hedge funds own it, we wanted to highlight Children's commentary on the name.  They're fans of the company's impending split and write:

"At the end of the quarter, the stock is on 11x forward earnings on our numbers and 6.5x EBIT. Low double digit net income growth driven by affiliate fees and re-transmission consent, and supported by the expectation of continued buybacks drives 20%+ net income growth and a 30% midterm IRR without a re-rating. We believe that as the market grows increasingly comfortable with the improved corporate governance at News Corp, the stock can comfortably achieve a 13-14x earnings multiple which 2 years out would point to a $37-40 target price compared to $22 today."


On Walt Disney

Lastly, Children's likes that the Parks segment will see capex programs slow down and think the company will see margin leverage.  They write,

"In the near term, margin recovery in the Parks and share buybacks will drive EPS growth up to near 20% for the next few years. We forecast EPS of $3.6 in the upcoming year and $4.2 in the following year. On a 14-15x multiple, this should give a share price trading target of around $60."



For more hedge fund Q2 letter excerpts, we've posted up:

- Eminence Capital on Google

- Scout Capital on Anheuser-Busch InBev

- Bill Ackman on why he sold Citigroup

Hedge Funds Pile Into QR National IPO (ASX: QRN)

A recent Australian initial public offering (IPO) has caught the eye of many prominent hedge funds. QR National (ASX: QRN), Queensland Rail's primarily coal network in Australia, recently became public with the backing of various new hedge fund owners. Shares IPO'd at AUD $2.55 and are now trading around AUD $2.77. It priced at the low end of the range and the Queensland government is left with a 40% ownership stake after the IPO raised $4.5 billion.

Adam Weiss and James Crichton's Scout Capital has disclosed a 5.1% ownership stake in QRN with 124 million shares (around a $316 million stake). We also recently detailed how Scout boosted its stake in Coca-Cola Enterprises (CCE). The Children's Investment Fund has also disclosed a 6.1% ownership stake in QRN with a $316 million position. Overall, 46% of QRN's recently IPO'd shares went to overseas investors with the buzz being that numerous other hedge funds have smaller positions.

Interestingly enough, a lot of domestic Australian long-only fund managers avoided the IPO as many argued it was overpriced. Hedge funds have clearly disagreed. Although we haven't been able to verify it yet, it's been rumored that Richard Perry's hedge fund Perry Capital had also taken a stake in the IPO. QRN is Australia's largest IPO since Telstra (Australia's monopoly phone carrier).

The propensity for hedge funds and investment managers in general to gravitate toward railroad plays is interesting. Some see these companies as attractive due to the oligopolistic nature of the business. Others fancy rails as plays on commodities, energy, or an economic recovery. Hell, Warren Buffett's Berkshire Hathaway even acquired rail company Burlington Northern Santa Fe in its entirety. And in the just released new issue of our Hedge Fund Wisdom newsletter, we see that many managers own shares of rival rail Union Pacific (UNP). And in Australia, this theme continues as QR National seems to be a play on coal.

Taken from the company's website, QR National is "QR National is the largest rail freight haulage operator in Australia by tonnes hauled, operating in key freight sectors and supply chains across the country. We are focused primarily on large, heavy haul rail tasks such as the transportation of coal, iron ore, other minerals, agricultural products and general freight as well as containerised freight."

Warren Buffett To Sell Union Pacific & Norfolk Southern Stakes (UNP & NSC)

Following Warren Buffett & Berkshire Hathaway's announcement of their Burlington Northern (BNI) purchase, we now see that he is set to make another round of moves in the railroad industry. As of last portfolio disclosures, Buffett owned shares in Burlington Northern, Union Pacific, and Norfolk Southern. Upon his impending acquisition of BNI, we now see that Berkshire Hathaway will sell their entire remaining 9.5 million shares of Union Pacific, a 2% stake in the company. Additionally, they will also sell their entire Norfolk Southern position of 1.9 million shares (or 1% of the company).

They will liquidate these positions between now and the impending transaction date for their BNI purchase as the news was revealed recently by Matthew K. Rose, chief executive of Burlington Northern. Buffett already owns 22.6% of BNI and will purchase the rest of the shares for $100 per share in cash and stock. In terms of other recent activity out of Buffett, we also saw that he has yet again sold shares of Moody's (MCO), his third sale this year. For more resources on Warren Buffett, check out Warren Buffet's recommended reading list, as well as the top 25 Warren Buffett quotes. Stay tuned next week as new disclosures (form 13F) will be filed with the SEC and we will update Berkshire's other portfolio activity.