Greenlight Capital 4Q16 Letter -Positioning for Trump Presidency

Smart Money

Greenlight Capital 4Q16 Letter, January 17, 2017

“Learning never exhausts the mind” – Leonardo da Vinci

  • Returned 4.5% net in 4Q16 and 8.4% net for the full year, relative to S&P which returned 3.8% in 4Q16 and 12.0% for 2016; since inception in May 1996, Greenlight returned 2,090% or 16.1 annualized net
    • Leading winners in 2016 were Consol (CNX), Time Warner (TWX), GM (GM), Michael Kors (KORS), and Apple (APPL)
    • Lost 11.7% in the short portfolio from oil frackers, Amazon (AMZN), Caterpillar (CAT), and Martin Marietta (MLM)
    • Macro contributed 2.7%, led by gold and natural gas
    • At year-end, average exposure of 106% long and 81% short
  • Views of what a Trump Presidency might look like:
    • Post-GFC, easy money policies have been good for Wall Street but bad for Main Street; it’s possible that Trump reverses these policies
    • To the extent he can implement his major agenda, economy should accelerate and there could be labor shortage
    • Monetary policy is poised to tighten; thinks ultra-low interest rates deprive households of income and raising rates from say 0.5% to 2.0% would give needed income to savers without significantly impacting corporate investment decisions
    • Wage inflation could become a drag on corporate profitability and higher inflation may force the Fed to raise rates substantially, potentially causing the next recession
  • In light of Trump presidency, thoughts on current positioning:
    • Long a variety of low-multiple, tax-paying, US value stocks: most benefit to companies that have profits on which to pay taxes (AMERCO, CC, Dillard’s, and DSW)
    • Long AAPL: to benefit from repatriation of foreign cash and tax reform
    • Long GM: more jobs, higher income, and higher wages to drive demand for consumer durables; also falls under low-multiple, tax-paying US value stock category
    • Short “bubble baskets”: mostly don’t have profits (no tax benefits) and accelerating economy should allow investors to find growth without needing to pay nosebleed prices for a narrow group of profitless top-line growth stocks (Netflix)
    • Short oil frackers: economies still don’t work when all investment and corporate costs are taken into account; “drill-baby-drill” attitude is likely to lead to additional mal-investment which will lead to lower prices and deeper losses; generally not cash tax payers
    • Short CAT (and a few other similar industrial cyclicals that have moved much higher post-election): CAT sells machines that are used in infrastructure but this is only a small part; CAT’s biggest segments are mining and energy; just completed once-in-a-generation boom in iron ore mine development and horizontal drilling which means we can produce more oil with fewer rigs; even in infrastructure boom, CAT closed the year at 33x forward earnings
    • Continue to own gold; there has been a knee-jerk decline in gold since the election, as investors presume that higher short-term rates are good for the dollar and bad for gold; great economic, geopolitical, and policy uncertainties, wider budget deficits, and possibility of inflation problem all support gold
  • GM:
    • Strengthening job market will sustain the current upcycle and lead to better than expected credit performance at GM’s finance subsidiary
    • Intermediate-term opportunity in assisted-driving cars
    • Trades at less than 6x earnings; it is rare for a company to pay out only a quarter of its profits in dividends and still yield 4.4%
    • Foreign operations that barely contribute to profits and could improve over time
    • Can unlock value through modest changes to its capital structure
  • E.ON: purchased in 4Q15 and when it spun out Uniper in September, kept the Uniper shares and sold the balance of E.ON stake at a modest loss to redeploy into more Uniper shares
    • Believe the market does not appreciate earnings stability of Uniper’s power generation and natural gas logistics assets
    • Incoming management team incentivized and committed to cost-cutting
    • Own the company at 6x 2017 expected earnings
  • Closed out several positions during 4Q16:
    • AECOM (ACM): modest return after successful URS integration; revenue synergies never materialized and declining oil and gas business added revenue headwind
    • Michael Kors (KORS): 20% IRR; exited because several growth drivers and European business disappointed and US department store promotions hurt KORS’ pricing power in its owned stores
    • Take-Two Interactive Software (TTWO): doubled money over three years; successful online launch caused earnings to exceed guidance and expectations; sold position along the way and completed exit in 4Q16 as analysts’ estimates have now caught up with ours
    • FLSmidth: covered a six-year short; company burned through its high margin customer backlog in cement and mineral processing equipment and was left with fewer lower-margin sales; FLS fell 28% during hold period
    • Mead Johnson Nutrition (MJN): covered short at a modest profit following a string of disappointments in its core baby formula markets of China, SE Asia, and US; still looks rich but the risk of a strategic buyout outweighed the upside of waiting for a lower price
    • Reynolds American (RAI): when Reynolds announced that it would acquire our short Lorillard in 2014, held to our thesis and shorted Reynolds; expected menthol regulations never came to fruition and in October, British American Tobacco announced plans to buy out the balance of Reynolds and we exited with a -38% IRR

Greenlight Capital, a long/short hedge fund with over $10B AUM as of 2015, is founded and led by David Einhorn.

Letter Source: Greenlight Capital, ValueWalk
Image Source: ValueWalk

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