Mar Vista January 2018: Everything is Awesome; XPO & CarMax

Smart Money

Mar Vista Investment Partners, January 2018

Everything is Awesome

  • Relentless rally provided a record 14 consecutive months of gains and only one quarterly loss in 5 years
  • Nearly 400 days passed without a cortisol-raising 3% drawdown. Household net worth was up 9% on the year and added another $10 trillion to consumers’ coffers
  • Despite accelerating growth in both developed and developing economies, inflation remained subdued allowing US, Japanese and European central banks to keep monetary policies loose
  • Tax Cuts and Jobs Act added a cherry on top as the Federal Government permitted shareholders to keep a considerably larger portion of corporate profits
  • Jeremy Grantham suggested a 50% melt-up phase could occur over the next 6-24 months despite being “as certain as we ever get in stock market analysis that the current price is exceptionally high”
  • Mar Vista portfolio achieved returns of 25.6% in 2017 vs. S&P 500 of 21.8%

The Fallacy of the Benchmark Game

  • Mar Vista applies an indirect, private equity-like framework to investment decisions: to outperform the passive benchmarks over time, one must invest independently of them
  • Mar Vista’s portfolio optimizes for the following factors:
    • Maximize intrinsic value growth: sustainable excess returns on invested capital drive intrinsic value. Earnings and revenue growth are components of the equation but the amount of capital required is equally important
    • Maximize margin of safety: a stock’s discount to fair value influences both expected returns and the risk of permanent capital loss. Simple multiples are the result of value, not the driver
    • Minimize the range of outcomes: probability-weighted scenario analysis and asymmetrical opportunities influence our weights more than simply emphasizing those with the most upside if our thesis is right
    • Maximize competitive advantage periods: the period that a business can generate excess economic rents drives value much more than near-term earnings or revenue growth. We will favor a business that can sustainably compound intrinsic value at 10% than one that can enjoy 15% earnings growth for a few years followed by more uncertain growth

Buy XPO Logistics (XPO)

  • XPO provides comprehensive supply chain solutions, primarily transportation and logistics, to various industries benefitting from the e-commerce revolution
  • Company enjoys rapidly expanding network effects from its contract logistics and last mile delivery as new shippers and customers enter the e-commerce marketplace
  • With only 1.5% market share of the fragmented $1 trillion global transportation industry, XPO has copious opportunities to compound intrinsic value both organically and via acquisitions
  • Capital allocation skills of Brad Jacobs, Chairman and CEO, are critical to our investment thesis
    • Prior to XPO, Jacobs successfully led two public companies: United Rentals and United Waste Systems
    • Jacobs invested $100 million of his own capital to start the company and currently owns 17% of the stock
  • Subsequent to our investment, XPO’s stock appreciated almost 20% when the market learned that the boards of both Home Depot and Amazon had discussed acquiring the company
  • We believe the market still undervalues Jacob’s strategy to build a collection of competitively advantaged assets in the last mile delivery and return of heavy goods, and XPO’s unique collection of technology, software and data

Buy CarMax (KMX)

  • Largest domestic used car retailer with a highly disruptive business model
  • Company delivers value to consumers through its fully transparent sales process and nationwide network of 65,000 high quality used vehicles
  • Since 1993, KMX sold over 6.5 million vehicles and appraised another 25 million used cars. The data intelligence collected from these transactions gives KMX a valuable informational advantage that is difficult to replicate
  • Over the past 20 years, KMX’s intrinsic value has compounded by 13% annually
  • With only 185 stores and 3% of the used vehicle market share, we think KMX has ample opportunities to expand its store base over our investment horizon
  • Other main contributor to intrinsic value is its CarMax Auto Finance (CAF) which provides used car financing solely to its prime customers
  • CAF’s loss adverse underwriting culture is another source of competitive advantage
  • CAF’s high-quality nonrecourse loan portfolio lowers its capital requirements to less than 1% of total securitizations
  • We think the benefits of the loss adverse underwriting culture and nonrecourse credit warehouse facilities supersede the earnings volatility
  • During the quarter, KMX’s stock declined 17% after same-store-sales slowed due to a temporary compression between new and used vehicle prices related to hurricane replacement demand
  • Eventually, excess used vehicle supply will force price depreciation to resume. We took advantage of these cyclical issues and purchased the equity at 13x normalized earnings

Image Source: Mar Vista Investment Partners