2019 Client Letter

February 2020

Dear Client,

Enclosed are the return calculations for your account(s). Where applicable, three, five, ten year and returns since inception are included as well. The S&P 500 returned 31.46% including dividends in 2019. Our composite returned 19.90% (individual results may vary). Since inception on 01/01/2000, our composite has returned 352% vs. 224% for the S&P 500. That represents a compound annual return of 7.84% for the composite vs. 6.06% for the S&P 500 with dividends.

Last year’s run-up in the stock market was principally the result of multiple expansion rather than increasing profits. Put simply, as interest rates fell, investors were willing to pay more for future profits. The 30-year treasury bond, which had been above 3% in early 2019, fell to about 2.25% at year-end and now sits comfortably under 2%. At the current price and yield, an investor can look forward to doubling their money in approximately 40 years! The S&P 500 ended 2019 with an earnings multiple of about 20, or, thought of another way, an earnings yield of 5%. It is no wonder that as an alternative to bonds, stocks did well.

The securities highlighted in last year’s letter; Discovery Communications +31.33%, Mohawk Industries +16.60%, Evoqua Water +97.40% and Stericycle Inc. +73.92% all performed well in 2019. Many of our long-term holdings, particularly those perceived as “steady growers” also did well and now sell at prices well in excess of their historical growth rates. Rather than trading on the fundamentals of their respective businesses, investors appear to be treating their dividend streams as bond proxies. Among the companies falling into this category are Nestle, Clorox, Republic Services and Waste Management to name a few. We have been sellers of this group. Detractors from performance in 2019 were energy-related securities; primarily those engaged in natural gas production and distribution.

The aforementioned sales of securities left us with a larger than usual cash balance. The cash is a byproduct of the sales and not a market timing mechanism. We are always on the lookout for investment opportunities that fit our margin of safety criteria. Towards the end of February 2020, Mr. Market obliged with a wholesale sell-off in response to the spread of the coronavirus. To be clear; we have no idea of how severe the short-term impact of the virus will be. We are, however, reasonably certain it will not impact long-term business value. Does it really make sense for a business to be worth 15%-20% less because the next quarter or two will experience a
slowdown? In order to be a successful investor, it is important that one insulate oneself from the cacophony of headlines and news. To succumb their corrosive emotional effects in no way improves the investment process and often sabotages it with knee-jerk reactions.
Many of the businesses we own have been purchased not only based on their attractive price relative to their cash generating capability, but also because their managements have articulated a coherent and well thought-out capital allocation strategy. Businesses have five things they can do with their capital: invest in organic growth, buy other businesses (mergers & acquisitions), paydown debt, repurchase shares and pay dividends. Smart managers make decisions on where that capital will generate the best returns and allocate accordingly. An opportunity to repurchase a meaningful part of the company at prices below a carefully calculated appraisal of value can be of great benefit to long-term owners. At certain price levels, aggressive repurchases may be the best use of capital.
Although we did more selling than buying last year, we did add two new positions: the stock and bonds of Chemours Company and the common shares of Camping World Holdings, Inc.

We became aware of Chemours through earlier investments in water remediation firms Calgon Carbon and Evoqua Water Technologies. Chemours was spun-out of the chemical company Dupont in 2015 and produces titanium dioxide (used primarily in paints and coatings) and refrigerants. The company’s next generation of refrigerants are more environmentally friendly than older refrigerants and are broadly protected by patents. The depressed shares currently trade in the mid-teens due to concerns over environmental liabilities. We think the liabilities to the company are vastly overstated due to confusion over a class of chemicals containing fluorine (broadly referred to as PFAS) which are the subject of a drinking water health advisory. Under the PFAS umbrella are PFOS and PFOA and although frequently used interchangeably, are different chemicals from different manufacturers. PFOS was used in firefighting foams and made by 3M and others. 3M recently booked a very large charge for costs associated with PFOS. Neither Dupont nor Chemours ever made or sold PFOS as a commercial product or used PFOS as a processing aid. Chemours could generate as much as $350 million in free cash flow this year or about $2.00 per share. While there are some other “moving pieces”, we believe the shares could easily double from current levels.

Camping World Holdings is by far the largest dealer in the fragmented market for new and used recreational RVs. Much like the “roll-ups” that occurred in the auto dealership industry, Camping World has the potential to become the next CarMax or AutoNation in the RV industry with all the associated benefits that scale brings. While a large component of the business is cyclical relating to the sales and financing of new and used RVs, a significant component, including parts and service and an underappreciated RV membership organization called the Good Sam Club, is not. Good Sam is a membership club where RV enthusiasts pay a yearly membership fee in exchange for discounts on gas, RV parks and merchandise. The club has more than 2 million members and creates a very steady revenue stream and marketing opportunities. An ill-advised acquisition of an outdoor sporting goods retailer in 2017 distracted management and affected results and the share price. That error has since been corrected and we see a very long runway for additional consolidation, increased club membership and future growth.

Like the seasons, stock market panics come and go. While they all have different origins, the attribute they all share is that they eventually dissipate. My first market panic experience as an advisor was in 1987 when the market fell over 22% (from 2,246 to 1,748) on a single day. If one looks at a long-term graph of the market, that event is but a tiny “blip”; almost invisible within the upward-sloping trendline. It is far more likely than not that the February 2020 swoon will share the same fate.
Please feel free to contact us with any questions or comments. As always, we thank you for your trust and patience.

Very truly yours,

Eckart A. Weeck

Senior Managing Director