John Heffern, Founder, KCA/Princeton Advisors
John A. Heffern is Principal and Founder of KCA/Princeton Advisors, LLC. His career includes nearly 30 years of senior level portfolio management and equity research mandates. He leverages a deep background in financial services for investment selection across a wide expanse of companies, themes, and factors. The fund follows a qualitatively oriented process in portfolio construction that is unique in the industry.
In this 4,239 word interview, exclusively in the Wall Street Transcript, the long/short hedge fund manager John Heffern details his investing philosophy and current portfolio positions.
“I would assert that we really are unique in terms of our overarching investment philosophy.
And in the way the world is developing these days in the investment industry, I think we’re increasingly unique. And what I mean by that is that investment management firms and strategies have rapidly evolved in quantitative directions.
We’re unabashedly qualitative in our investment foundation.
We really do believe strongly that people with the right skills and philosophies and incentives are the last mile of execution and risk management, and that’s where we start. We start with the people, and that’s also where we end.
And we hand-select our investments based on our confidence in management, the underlying franchises of the businesses, their operating and governance philosophies. And so we favor long-term reliability over the allure of short-term momentum.
In this way, corporate governance matters in a broad sense that captures strategy, risk, incentives, aspirations, predictability, and reliability.
Given our focus on financial services, we invest in capital-intensive, highly regulated sectors and companies. And you can’t escape the importance of people and culture.
So as the world evolves toward quantitative momentum and artificial intelligence, we know that people are still key, particularly in regulated companies. And that’s where our focus and our experience come together and create a unique advantage.”
The long/short hedge fund portfolio positions are unique as well.
“…In my opinion and based on observations I get from bank managements who I talk to — is yes.
Many, many small businesses initially went perhaps to their core bank relationship with a larger bank. They were disappointed with the service level and the speed and ease of reaction in terms of having their loans underwritten and funded in a seamless way.
So they then turned to smaller local banks in their communities, which responded very quickly and very efficiently. And I think that has generated goodwill which has resulted in relationships moving from larger banks to smaller banks, certainly, at the margin.
I’m not going to say there’s been a groundswell of market share shift from the biggest banks in the country to the smallest banks in the country.
But I do think what we saw and continue to see in the pandemic — from a service perspective — is something that re-emphasizes the use case for community banking and regional banking in America. Now, that’s in the near term.
And the duration of that feeling of goodwill is something that we will only fully understand as we progress through time.
To be fair around all of this, there remain significant structural changes that are occurring in a society that’s becoming more digitally oriented. And those pressures on small banks versus large banks will continue unabated.
This is to say that the very large banks have the wherewithal to invest hundreds of millions of dollars, even billions of dollars, in technology innovation that we’re all seeking.
That ultimately drives market share in their direction. Those pressures will not go away.
But as I said, in the short term, from a pure service point of view at a time of great need, the use case for community banking was re-emphasized during the pandemic.”
The long/short hedge fund portfolio manager is devoting his money to this fundamental economic position.
“I want to go back and re-emphasize the qualitative aspect of our investment process.
We are very focused on management teams, their franchises, and conversations with those teams about how they’re running their banks, their governance priorities, and their perspective on opportunities and challenges going forward.
We also think, as we mentioned, that there will be consolidation — more M&A.
And in the space of community and regional banking, you can benefit both ways.
You can own buyers of other banks in accretive transactions, and you can own banks that sell for premiums.
Our approach has been to pursue a basket of favored investments in a community bank space. And just to name two or three: Atlantic Union Bankshares in Virginia (NASDAQ:AUB); Prosperity Bancshares in Texas (NYSE:PB); Peoples Bancorp in Ohio (NASDAQ:PEBO); and even a tiny bank, which very few investors would have heard of that we’ve owned for some time, Oak Valley Bancorp, out in California (NASDAQ:OVLY).
Banks like these operate all over the country.
They tend not to get Wall Street attention. And we like that. We do our work independently. We like the management teams in each of these companies. And we think that we have optionality either on the buying side or the selling side wrapped in very strong fundamentals and appealing valuations.
So we’ve taken a basket approach with these companies.
We are very happy with the performance we’ve seen from all of them through the pandemic and the outlooks we’re hearing from management as we enter 2021 and progress toward 2022.”
Another side of the long/short hedge fund portfolio are larger capitalization financial institutions.
“We think there is an opportunity on the turnaround side for companies that are cheap, where there has been significant management and cultural change and where valuations remain significantly discounted.
And that for us includes Deutsche Bank (NYSE:DB), which after years and years of regulatory and compliance errors, has embarked on a significant improvement in enterprise risk management and cost efficiency under a new CEO who arrived a couple of years ago.
We think the company has made great progress.
It will continue to make significant progress not just on the cost side, but on the revenue side.
And the shares are trading at a dramatic discount to its peers and to the group generally — well less than 50% of tangible book value.
So if Deutsche Bank can deliver on its financial goals and aspirations over the next year or two, we think the shares have 50% to even 100% upside.”
Get all the top picks and positions in the long/short hedge fund by reading the entire 4,239 word interview with John Heffern, exclusively in the Wall Street Transcript.
John A. Heffern, Founder, KCA/Princeton Advisors, LLC
www.kcaprinceton.com
email: jaheffern@kcaconsult.com
Stephen Davenport, Director of Alternative Investments, Decatur Capital
Stephen Davenport is the Director of Alternative Investments at Decatur Capital Management Inc. and is responsible for the firm’s Alternative strategies including buying puts for equity portfolio insurance.
He has an extensive knowledge of equities, derivatives and market dynamics, and uses a combination of quantitative and fundamental approach in managing assets.
Mr. Davenport received a B.S. degree in industrial engineering at Columbia University, a B.S. degree in math/computer science at Providence College, and a M.S. degree in finance from Boston College.
Mr. Davenport began his career as an Industrial Engineer in the manufacturing industry, and then moved into finance, working for State Street Global Advisors in the Private Wealth Management group. At SSGA, he developed a tax-optimized solution that utilized alpha, tracking risks, taxes, and other transaction costs for over 5,000 accounts.
After obtaining the CFA designation, he began directing derivative strategies at Fleet Bank. Mr. Davenport moved to Atlanta for the role of Director of Equity Risk Management at Wilmington Trust.
He developed strategies for premium income, exit and buying puts and calls for equity collars.
After Wilmington Trust, he became a Private Wealth provider at SunTrust managing derivative strategies. Mr. Davenport has held multiple volunteer roles and leadership positions with the CFA Society Atlanta, ASFIP Foundation.
During his role as President, he established a financial literacy foundation, with the main goal of helping the metro Atlanta community. In 2019, he received the FLY (Financial Leader of the Year) award from McCracken Alliance for his work in the financial literacy field.
In this 4,363 word interview, exclusively in the Wall Street Transcript, Mr. Davenport details buying puts as a strategy for his clients as well as a variety of other option trading tactics.
“We can sense the market is pretty overstimulated from a standpoint of liquidity that’s being provided by ultra-low rates. The buying of a lot of instruments by the Fed. The fiscal stimulus that’s been put in place and is going to be further added to has created unprecedented liquidity, which causes distortions.
When interest rates go below the rate of inflation, they’re basically real negative returns. People have to then take assets out of bank accounts and put them to work in risk markets. You look at what happened with GameStop (NYSE:GME), and there was obviously a lot of people who were on Reddit with money.
They probably had stimulus payments, and when you don’t differentiate who gets a stimulus, it creates liquidity, and that liquidity has to go somewhere.
I think we’ve seen very unusual things going on with some of the IPOs, SPACs and some of what’s happened in Reddit with GameStop and AMC theaters (NYSE:AMC). Companies aren’t necessarily doing anything that I would say is wrong or right.
The reaction of media and the idea of Robinhood, it was really a very strange story, right? I grew up talking about Robin Hood as taking from the rich and giving to the poor, and I’m not sure that the people who were making money on the Robinhood trades were the poor.
It’s just a strange characterization of the hedge funds who are losing money, but there were probably just as many hedge funds who were making money. There were probably people that said, “Hey, I’m going to take the other side of this trade and get behind all these people and take advantage of that momentum.”
It’s very hard for us to sound bite the markets and say, “Here, I’m going to take all of these trades and all the things that are happening and I’m going to give you a 15-second summary.” Markets are a little more complicated.
There was a lot of use of options and specifically call options. Seventy-five percent of the options used in August were duration of less than two weeks. I don’t consider that investment decisions if you’re horizon is two weeks or less and you’re using leverage to implement it. I think of investing as a one-year to three-year horizon. When you have a timeframe less than that, I consider that trading, not investing.”
Buying puts would have been a successful portfolio strategy for Cisco executives in the early 2000s:
“I remember when we looked at Cisco (NASDAQ:CSCO) in 2000 and we said, “Cisco is going to be a trillion-dollar company; they are going to continue to have 40% growth in revenue for the next five years,” and it really was like, “How are we going to use that much bandwidth?” We’re saying the same thing with some of these names like Tesla (NASDAQ:TSLA) and Amazon.
They are huge market caps. How do we see them fitting into that market cap and making it more reasonable in terms of a p/e multiple? It’s very difficult to get to those, so I look at a name like Etsy that’s smaller, that has a huge market runway in front of it and sells at a similar multiple. Degas feels that maybe Etsy is the better way to play stay-at-home, small business growth.
Another example would be GM (NYSE:GM) versus Tesla. We looked at the auto space and the EV market, and Tesla, most of their revenue now is coming from carbon credits, and you look at their actual vehicle sales and it’s a small percentage in terms of their profit.
You look at a car manufacturer like GM and their Volt and other things that they have in the pipeline, and you realize that they’re building a traditional business where they’re looking at profitability per vehicle, and they’re being priced in the EV space as their multiple per vehicle, versus the multiple on Tesla per vehicle is just quite a bit different.
So we looked and said, if we think EV is going to be a disruptor and is going to continue to grow, who is going to be the beneficiary? With Tesla up 750% last year, it’s hard to get in that car. It’s hard to go for that ride when you look at GM and they’ve got a huge commitment to the space and they’ve got a deep capability and they’ve got extensive infrastructure.
Somebody is going to build this EV industry out. Isn’t Tesla more of a specialty carmaker and is GM more of a general carmaker?
The general vehicle switching to EV — there’s a lot more vehicles that are going to get sold in the $10,000 to $30,000 range than are going to get sold in the $70,000 to $90,000 range. We just felt that GM might be the exposure that we wanted to take to gain EV exposure.”
Get more insight into buying puts and other option strategies by reading the entire 4,363 word interview with Stephen Davenport, exclusively in the Wall Street Transcript.
Stephen Davenport, Decatur Capital Management Inc., email: sdavenport@decaturcapital.com
Bobby Edgerton, Chief Investment Officer, Capital Investment Companies
Bobby Edgerton is a Co-Founder of the Capital Investment Companies and has served as an executive officer of the companies since 1984. He is also the firm’s Chief Investment Officer and has been in the financial services industry since 1979.
After winning the North Carolina State High School Golf Championship, Mr. Edgerton accepted both a basketball and golf scholarship from Wake Forest University and graduated with a B.A. in business and finance.
After graduation, he attained a rank of First Lieutenant in the U.S. Army Signal Corps, where he commanded a thousand-man training company at Fort Gordon, Georgia, during the Vietnam War. During his amateur golf career, Mr. Edgerton played in four United States Amateur Championships.
In this 3,889 word interview, exclusively in the Wall Street Transcript, Bobby Edgerton details his 2021 investment picks and his investing philosophy.
“My philosophy is that the essence of the stock market is twofold, very simple.
Every company, big and small, has two values. Number one is precisely to the penny what the stock market says a company is worth.
Walmart (NYSE:WMT) has 3 billion shares outstanding. The stock is right at $140, so the stock market says the company is worth exactly, say, $400 billion.
Coca-Cola (NYSE:KO) has 4 billion shares outstanding. The stock is around $50, so the stock market says the company is worth $200 billion.
There is no way Coke is worth half of Walmart. But what the stock market does is put an exact value on every stock, which you can’t do. It’s really a range.
So, the essence of the stock market is twofold. You have that first precise value, and then the second is, what are these companies really worth? Or what’s Apple really worth with their technology?
What’s Google really worth, Alphabet (NASDAQ:GOOG)? You can’t pin it down to an exact value.
It’s kind of a range that these companies fit into. And what one wants to do, is when one of these stocks gets oversold, and is selling at a low price for the year, the company is probably worth more than the market is valuing the company.
On the other hand, when a stock goes way up, and they’re at an all-time high, then you might think that some of these companies aren’t worth what they’re being valued at right now.
And I’m talking about the Zooms (NASDAQ:ZM), the Palantirs (NYSE:PLTR), the Oktas (NASDAQ:OKTA). Now, they’ve all gone public. A lot of them don’t have any cash flow or maybe minuscule cash flow. So that’s the essence of the stock market.
I have a five-point program for investing.
If one does these five things, they’re probably going to make money and most importantly, not lose much money.
Number one is you buy companies that have great balance sheets, and in many cases a lot of cash. Not much, if any, debt. And you buy the best companies in the world.
Maybe number one or number two, like Taiwan Semiconductor (NYSE:TSM) in chip manufacturing, or Coca-Cola in beverages, McDonald’s (NYSE:MCD) in fast food, things like that. So that’s the first thing you do. You buy nothing but good companies. You always buy when they’re down, not when they’re way up.
Number two is you never spend a dividend.
You always reinvest your dividends. The average good company like Coca-Cola and Walmart double their dividend every 10 years. Lockheed Martin (NYSE:LMT), the big defense company, quadrupled its dividend last year. If you need dividends to live on, that is another matter.
Number three is savings and premiums.
If you go through your life, or your business life, in your retirement plan constantly accumulating great companies, especially the ones that have sold off, you’re going to do well in the stock market. And so, that’s, kind of, savings.
Premium is something that you obligate yourself to do. Maybe you buy one good stock a month. In a year, you’re going to have 12, and in five years, you’re going to have 60. Even if you might not do well in the stock market, if you saved a lot of money, you’re probably going to be in good shape.
The fourth part of the five-point program is tax.
Obviously, in an ERISA account, where there are IRAs and 401(k)s and the like, you don’t pay any tax until you’re 72. And then you have to start taking out your required minimum distributions.
In a taxable account, if you make your gains, long-term gains, obviously, you pay a lot less tax than you do on short-term gains.
And then the fifth point of the five-point program, and probably the most important, is the two ways you make money in the stock market.
You buy good companies and you hold them forever. You hold them and don’t ever sell. You don’t pay any tax unless they change the rules on you and start having some kind of tax on it, which they don’t do now.
Someone who’s held Coca-Cola for 50 years, or Walmart for 25 years, or Apple, like I have, for 25 years. That’s a good way to make money.”
Bobby Edgerton has some top picks for 2021.
“My number-one turnaround would be Coca-Cola.
Coca-Cola is in the best shape they’ve ever been. James Quincey is, in my opinion, the best CEO they’ve ever had. They’ve had some tough guys back in the day. Doug Ivester was not a very popular guy. He was just a tough guy. But Quincey is a great guy.
I used to run a Coca-Cola bottling company’s retirement plan.
And the owner always told me that Coke did not belong in the bottling business. That’s a capital-intensive business. They should sell concentrate and all the other beverages.
Well, none of them ever did that until Quincey came along and did that. So, Coke, they own stock in their bottlers. Like Coca-Cola European Partners (NYSE:CCEP). But they’re essentially out of the bottling business which I think is a good move.
And Quincey — he just had a massive selling of the beverages that weren’t performing.
Pepsi (NASDAQ:PEP) is a big in-house company with Frito-Lay, where people stay home and they eat the munchies.
Coke is an external company where people get out and they mingle, they go to restaurants, which I think is going to come back. And when that happens and when the sports open back up, then Coke is going to be a big winner.
But it’s in the doghouse right now. And I like buying good companies when they’re in the doghouse.”
Get the other top picks from Bobby Edgerton by reading the entire 3,889 word interview, exclusively in the Wall Street Transcript.
Sam Dunlap, Chief Investment Officer, Angel Oak Capital Advisors
Sam Dunlap is a Managing Director and Chief Investment Officer of public strategies at Angel Oak Capital Advisors and serves as a Portfolio Manager for the Angel Oak Multi-Strategy Income Fund and the Angel Oak Multi-Strategy Income UCITS Fund.
He also manages some of the separately managed accounts for the Advisor’s clients. Mr. Dunlap joined Angel Oak in 2009, and serves as a voting member of the firm’s public funds Investment Committee.
He has also been featured as a television guest on Bloomberg, CNBC, Fox Business, and TD Ameritrade Network as well as quoted in Bloomberg and Barron’s.
He began his capital markets career in 2002 and has investment experience across multiple sectors of the fixed-income market. Prior to joining Angel Oak, he spent six years marketing and structuring interest rate derivatives with SunTrust Robinson Humphrey where he focused on both interest rate hedging products and interest rate linked structured notes.
In this 2,672 word interview, exclusively in the Wall Street Transcript, Mr. Dunlap details the financial thesis for his short term high yield fixed income portfolio.
“As far as volatility is concerned and to your point on volatility within the U.S. — whether it relates to capital markets or U.S. growth ahead, for example — we do think that the Fed and the recent commitment to the zero bound and QE4 is an incredible volatility suppressant, particularly for risk assets.
Hence the mortgage allocation, as I mentioned, is the overweight within the fund at over 65% of the allocation.
Given how profound the Fed’s commitment is to QE4 and buying agency mortgages, we’ve seen interest rate volatility collapse just as you’ve seen volatility collapse across all the risk markets, including the VIX.
We believe this is hugely supportive to continue to suppress volatility, which is supportive for mortgage credit, generally speaking. We think our volatility outlook for the years and months ahead bodes well for the mortgage allocation.
Our goal is to provide investors with the best relative value that will pay over the long run credit cycle, and in addition to low volatility, the U.S. mortgage credit market has been benefiting from positive fundamental credit attributes.
The Fed’s commitment to the zero bound and buying mortgages, as well as collapsing interest rates has been hugely supportive for U.S. housing, which from a fundamental perspective, improved the credit risk profile of the bonds we target within non-agency RMBS.
There were some questions to your point on volatility in the U.S. economy surrounding unemployment and rising delinquencies in RMBS due to the pandemic. As we took a step back and reflected on the post-COVID environment from a top-down standpoint and what it meant for RMBS, we were reminded we were very bullish towards U.S. housing and non-agency RMBS going into COVID due to the incredible supply and demand dynamics supporting U.S. housing.
There’s just a general shortage of supply and rising demand. We became even more bullish towards U.S. housing and non-agency RMBS post COVID. We have been pleasantly surprised to say the least with what has transpired post COVID as it relates to housing and RMBS.
The performance has been extraordinary.
It was not immune to what we saw with the volatility during the March period. As all credit products were particularly hard hit, mortgage credit was not immune to similar spread widening, but the fundamental credit aspects that back the bonds we target have improved dramatically post COVID.
I don’t anticipate potential volatility ahead to change our current outlook and backdrop to the macro tailwinds that benefit mortgage credit over the medium term.
One of the things that we have shifted towards post COVID are more areas of consumer ABS — that is an area that has benefited from similar macro tailwind to mortgage credit.
Rates obviously collapsed on the front end and improved financing costs has really benifitted areas like auto ABS. Additionally, U.S. consumers were in solid shape going into COVID, and in our opinion, U.S. consumers were very well positioned to stave off the worst from the pandemic.
Personal savings rates as a percentage of disposable income were rising going into the COVID crisis, and they subsequently spiked to post-WWII all-time highs. We and other market participants took note.
We believed there were some excellent opportunities within the consumer ABS space, particularly auto ABS coming out of the COVID environment.
That has, again, been a pleasant surprise given our outlook, as used car prices increased dramatically — similar to the dynamic for U.S. houses.
We felt, even if the U.S. consumer were to fall under more undue pressure by not passing additional stimulus, the collateral value that backs the auto ABS were improving in a dramatic V-shaped fashion.
Consumers not only bought homes to escape the ills of the COVID crisis, but they also bought cars.
Our allocation targets were consistent going into the COVID crisis, but that gives you a sense of how we thought of it coming out.
CMBS is an area we actually decreased the allocation after the COVID-related volatility. Commercial real estate is a sector where we have concerns about the integrity of the long-term leases in areas like retail, which was a concern for us prior to COVID; office, given the acceptance of the work-from-home environment; and hospitality, which has been particularly hard hit.
Prior to COVID we were biased towards being up in quality in CMBS. Post COVID we not only maintained our up in quality bias, but we have predominantly targeted agency-backed CMBS in the post-COVID environment.”
A short term high yield fixed income portfolio is difficult to achieve in this market environment but Mr. Dunlap has centered his portfolio on low volatility assets that he believes in.
“Angel Oak Capital Advisors manages approximately $10.8 billion in fixed income. We focus on the U.S. structured credit markets and predominantly in mortgage credit.
This fund from a strategy perspective is approximately $7.4 billion in size. We also have a UCITS version of this fund as well, the Angel Oak Multi-Strategy Income UCITS Fund.
What we seek to identify within the U.S. structured credit markets provides a unique allocation for investors seeking high current income and a unique allocation away from traditional fixed income in the U.S. structured credit markets.
This fund has a unique allocation and an overweight to non-agency RMBS and predominantly legacy non-agency RMBS — bonds that were issued prior to the global financial crisis. It has over approximately 65% of the allocation towards non-agency RMBS.
The allocation gives investors high current income, with a relatively short effective duration profile, which we think is unique given the current environment of historic fiscal and monetary stimulus.
Here, at the zero bound, we are seeking to provide investors high current income, with low interest rate sensitivity.”
Read the complete details of how Angel Oak has developed this short term high yield fixed income portfolio for individual investors by reading the entire 2,672 word interview with Sam Dunlap, exclusively in the Wall Street Transcript.
Richard Murphy, Chairman and CEO, Enervco Corporation
Richard A. Murphy is the Chairman and CEO of Enservco Corporation and was appointed as an independent director to Enservco Corporation’s board of directors on January 20, 2016. He is managing member of Cross River Capital Management, LLC, the general partner of Cross River Partners, L.P. Cross River Partners, L.P., is an institutional investor in micro-cap and small-cap companies with market capitalizations up to $1.5 billion.
Mr. Murphy is responsible for investment research and analysis and for coordinating final investment decisions.
Prior to joining Cross River, Mr. Murphy was an analyst and assistant portfolio manager with SunAmerica Asset Management, LLC; an associate investment banker in the food and agriculture division at ING Barings; and a second vice president at Chase Manhattan Bank.
He is a former member of the Advisory Board of CMS Bancorp, Inc., and currently sits on the Applied Investment Management Board for the University of Notre Dame. In addition, he is on the board of MRI Holdings, a non-reporting restaurant company.
Mr. Murphy received his MBA from the University of Notre Dame-Mendoza College of Business in 1998 and his bachelor’s degree in political science from Gettysburg College in 1992.
In this 2,821 word interview, exclusively in the Wall Street Transcript, the Enservco CEO and director details his oil and gas drilling services business.
“Today Enservco provides three basic services: frac water heating, hot oiling, and acidizing.
Since 2004, we’ve grown from about 15 to 20 trucks, to today we have 62 hot oilers, 82 heaters and six acidizers.We are one of if not the largest player in the heating business. We have a national footprint.
We’re in five yards. Our headquarters is in the DJ Basin in Colorado. We have a pop-up yard in Wyoming. We’re in North Dakota, in Tioga. We’re in Texas, in both Carrizo Springs and southern Texas — in the Eagle Ford, not the Permian, which is much more competitive pricing.
And we’re in Pennsylvania. Pennsylvania has much more natural gas to it, so does the eastern half of Wyoming. We have a mix of both oil and gas.
Certain basins are more active than others. We’re able to move to those basins, unlike many of our competitors.
Particularly in the heating space, many of our competitors are mom and pops with two to three trucks — so we have a bit of a competitive advantage from that standpoint.”
The Enservco CEO discusses last year’s brutal economics for his sector:
“2020 was a tough year with the number of bankruptcies in the energy space.
I was talking to a friend who’s been in the oil patch since the 1980s — he’s a CEO of a major oilfield services company — and he says it’s the worst since the ’80s.
Obviously, there’s going to be a swing back a little bit. Drilling went from high 900s to 1,000 fracturers out there, down to as many as 200 at the bottom in the fourth quarter.
We’re definitely seeing the snap back in terms of demand from our clients. We have a lot of MSAs — Master Service Agreements — with all the big players, probably close to 100 MSAs, so we do touch all the big E&P companies.
And I would describe it as, we’re in Phase I. There’s definitely a cautious approach to getting out there and drilling, but we’re seeing a lot of workover rig activity, meaning if you have DUCs — drilled but uncompleted wells — you’re seeing those being opened up. That’s the low-hanging fruit, if you will.
There’s a lot of discussion about capex budgets in the second, third and fourth quarter being increased if this oil price stays where it is.
That being said, we were on pace to do 13 million barrels a day oil in the United States two years ago — everyone’s talking about going north of that, and I just recently read that we’re on pace now to do about 7.5 million barrels a day.
You just can’t flip the switch that quick; that supply coming out of the market is going to have a price impact worldwide. Hopefully the industry remains cautious and we get to that 800, 900 activity type level, which would be great for our business.”
Hot Oilers are the key to success for Enservco:
“I am trying to transform this company from a heating-first company to a hot oiling-first company, because of this aspect: Hot oiling occurs throughout the year, it’s not seasonal and it’s not based on weather.
There is some slight seasonal uptick, but not a lot.
We just did an offering that closed this morning. It really positions our company; it gives us a lot of strength on our balance sheet, which we haven’t had in the last couple years. That’ll give us an opportunity to really get into this hot oiling space and maybe try to become one of the biggest players in that space.
The margins in the business are terrific. It’s hard to get a hot oiler right now; the demand for that has ticked up quite a bit because of what I described earlier. So I’m really excited about that business. I think it has legs for quite a few years.
One of the biggest barriers to entry to that business is people. It’s hard to find a good hot oiler. What we can bring to the table is, if you can give them good equipment and consistent work, you can get the hot oilers.
Like I said, these mom and pops that — if you can only get 20 hours one week or 40 hours the next, they’re going to have a hard time getting and retaining quality people. The hot oilers come with a book of business.
It’s almost like Wall Street brokers. If you get one, he can bring a team over, and they have good contacts. We’ve experienced that firsthand recently.
I think it’s a great business if we could be a big player in it. And then I want the heating business to be that cherry on top of the ice cream, where if we get a cold winter like we’re having this year, we can generate a tremendous amount of revenue.
Margins are great, and that’ll be a real bonus for our company.”
Get the full detail on Enservco and its future growth by reading the entire 2,821 word interview with the CEO and Chairman, exclusively in the Wall Street Transcript.
Robert D. Bondurant, President & CEO, Martin Midstream Partners
Robert D. Bondurant serves as President and Chief Executive Officer of Martin Midstream Partners L.P. and is a member of the board of directors of its general partner.
Mr. Bondurant joined Martin Resource Management Corporation in 1983 as Controller and subsequently as Chief Financial Officer from 1990 through 2020 and continues as a member of its board of directors. Mr. Bondurant served in the audit department of Peat Marwick, Mitchell and Co. from 1980 to 1983.
He holds a bachelor of business administration degree in accounting from Texas A&M University and is a Certified Public Accountant, licensed in the state of Texas.
In this 2,889 word interview, exclusively in the Wall Street Transcript, Mr. Bondurant details his strategy for Martin Midstream Partners.
“From the IPO date of November 2002 through 2014, we had substantial growth through access to capital.
Some of this growth was in areas that had upstream energy exposure, such as gas processing and fractionation in East Texas, and investment in West Texas LPG, which is an NGL pipeline, a crude storage terminal in Corpus Christi, and natural gas storage in North Louisiana and Mississippi.
These investments were large and had nice early returns, but with the energy commodity price collapse that began in late 2014, we made strategic decisions in 2015 to sell assets that had volatile upstream exposure and refocus on what we do best — providing services to refineries, including logistics through land and marine transportation, as well as terminal services.
We also provide marketing services for the byproducts that refiners produce, such as sulfur and natural gas liquids.
As a result, we have four segments: terminalling and storage, sulfur services, transportation, and natural gas liquids. Although these four segments are different, they have a common thread — all of these segments are servicing refiners in some form or fashion.”
This emphasis by Martin Midstream on refinery servicing has lead to a focus on several businesses.
“Let me begin with the terminalling and storage segment. First, we have approximately 30 terminal facilities, mostly located along the Gulf Coast, with storage capacity of approximately 2.8 million barrels.
Our specialty terminals receive hard-to-handle products from refineries and natural gas processing facilities, storing them for delivery to our customers. These specialty products include asphalt, natural gasoline, sulfuric acid, and ammonia, just to name a few.
Also within this segment, we own and operate a small naphthenic lubricant refinery located in southern Arkansas that includes a lubricant packaging facility, where we blend and package private label lubricants for use in the automotive and commercial industries.
Finally, within this segment we operate facilities in Kansas City, Missouri, in Houston, Texas and Phoenix, Arizona, to process and package specialty grease products, such as post-tension grease.
Next is our sulfur services segment. Within this segment we have two business lines.
First, in what I like to refer to as the pure sulfur segment, we aggregate, store and transport molten sulfur from Gulf Coast refineries to our terminals in Beaumont, Texas. The molten sulfur is shipped by our own barge to Tampa, Florida, where it is used in domestic fertilizer production.
We also convert molten into prilled sulfur, which we store for our refinery customers.
Basically, the molten sulfur goes through a water bath process that converts the liquid to a small solid pellet. This prilled sulfur is eventually loaded onto dry bulk vessels for international delivery, where it is remelted for use in fertilizer production.
Based on a five-year average, approximately 70% of prilled sulfur exports from the U.S. Gulf Coast originate at our terminal in Beaumont.
The second business line within our sulfur segment is the production of sulfur-based fertilizers, which are marketed to wholesale fertilizer distributors and industrial users. Here we purchase molten sulfur from refineries and use it as a feedstock to convert to fertilizer. These sulfur-based fertilizers are used in corn crop production, making corn acres planted a key driver of this business.
Moving to our transportation segment, we own both land and marine assets. Our fleet of tank trucks service the petroleum, petrochemical and chemical industries. We deliver hard-to-handle products for refineries and chemical companies across the U.S. with our fleet of specialty trailers.
In addition, our land assets are utilized by our other business segments. For example, land transportation delivers sulfur from refineries to our sulfur terminals; NGLs for the natural gas liquids segment; and lubricants for the terminalling and storage segment.
On the marine side, we utilize both inland and offshore tows to provide transportation of petroleum products and petroleum byproducts. As within the land group, we handle specialty products for oil refiners and international and domestic trading partners.
Finally, our natural gas liquids segment purchases and stores NGLs, both from and for delivery to refineries, as well as industrial users and propane retailers.
Within this segment, we have approximately 2.1 million barrels of underground storage. Of that, approximately 400,000 barrels are used in our seasonal propane business.
The other 1.7 million barrels are dedicated to our butane optimization business. Refineries excess butane during the summer months, but require butane during the winter months for gasoline blending purposes.
This supply/demand imbalance creates opportunities for us to utilize our underground storage assets in service to the refineries.
Lastly within the NGL segment, we deliver natural gasoline from refiners and natural gas processors to our Spindletop terminal in Beaumont, Texas. This terminal then supplies the local petrochemical industry with natural gasoline for use as a feedstock.”
The Martin Midstream CEO sees a long term value for his company, despite recent trends toward renewable energy sources:
“Regarding the movement towards decarbonization, first, I believe this will take a considerable amount of time to implement.
Second, I believe our assets and the majority of our operations around the Gulf Coast refinery corridor are strategic longer term. Refineries in our area of operations are the largest and some of the most sophisticated refiners in the U.S.
There’s adequate crude supply to them by pipeline and by VLCCs. In fact, some of these Gulf Coast refineries have made investment decisions to expand over the next two to three years.
Because of these investment decisions, it appears they plan to operate the assets long term.
So my point is this: If there is a time in the future where there will no longer be any need for gasoline, diesel, jet fuel, marine fuels, or even asphalt, my view is that refineries we service in the Gulf Coast will be the last refineries to cease operation.”
Get the entire detail on Martin Midstream’s future plans for increasing the value of the company for investors by reading the entire 2,889 word interview, exclusively in the Wall Street Transcript.
Sunil Sibal, Managing Director, Seaport Global Securities
Sunil K. Sibal is a Managing Director at Seaport Global Securities LLC. He has more than 25 years of progressive international experience in the energy infrastructure sector, most recently at Seaport Global, which he joined in 2014 to cover and build out the firm’s MLP/midstream infrastructure research.
Prior to that he was with Citi, where he covered the midstream MLPs and built out the various commodity forecast models. Prior to Citi, Mr. Sibal held roles identifying investment opportunities in the natural resources and energy sector at BofA and Natixis, as well as project development and engineering roles at Fluor and ABB Lummus Global (CVX JV).
He holds an MBA with High Distinction from Ross School of Business at the University of Michigan and a bachelor’s degree in Chemical Engineering from Panjab University in India.
In this 3,035 word interview, exclusively in the Wall Street Transcript, Mr. Sibal details his best investment opportunities for 2021.
“If we start with opportunities first, I think there is a clear recognition that although in the U.S. there will be a lot more push towards renewable energy, not all parts of the globe are in the same spot.
So, to the extent that U.S. gas, oil and even natural gas liquids production goes to export markets and can help some of those markets also make that transition to — obviously, they’re starting from a very different point, so the terms of reference are very different — but U.S. oil and gas can facilitate that transition. There are opportunities there.
In terms of the assets within the U.S., there is within the renewable space focus on renewable diesel and more ethanol. A number of refiners, for example, announced projects to convert their refineries to renewable diesel production.
I think infrastructure, with regard to the extent that you need pipes and tanks, you won’t need new pipes and tanks, but you will need some retrofitting of those to handle this renewable diesel and ethanol and all that. So there will be opportunities there.
Then on the gas side of things, obviously renewable natural gas, which can be sourced from animal farms and all those sources, they still need infrastructure to get that gas into the network and move that gas.
And then hydrogen is being talked about, too, in a significant way — I think more so in Europe than the U.S. because of the way their system is set up, but there has been some focus on hydrogen also in the U.S.
To the extent that it can be mixed with natural gas and burned for power generation, there are opportunities for the infrastructure companies to facilitate that. So those are, I think, areas which I would put in the plus category or opportunity category for the infrastructure players.”
These sector relationships with the regulatory framework lead to some specific energy infrastructure stock picks from Sunil Sibal:
“Plains is primarily a crude oil-focused midstream player, and one interesting theme is that commodity prices have recovered — crude is almost to pre-COVID levels.
If you look back, last year crude oil for WTI contracts was trading at around $60, and right now we are in the $55-plus range, so we’re almost there — but the infrastructure players, the way they make money is not from a direct selling of commodity, but when the higher commodity price leads to more activity and more production.
We’ve seen the commodity price recover, but interestingly, Plains still thinks that activity levels from the U.S. side will be fairly tempered and we would not be anytime soon going back to the pre-COVID production levels that we had seen.
Keep in mind, Plains infrastructure assets are basically more tied closer to the wellhead of crude production, so they are closer to the supply side of things rather than crude demand side of things, so obviously that plays a part.
But I would say that the most notable thing for me was their cautious approach in dealing with 2021. Obviously there was some kind of optimism going in that because the commodity price is strengthening — and we’ve seen also the drilling rigs start to move up, and all that — there was expectation that the 2021 guidance would be more robust than what it came out to be.
Part of it could be just a cautious approach on the part of Plains management, so we’ll have to see how the year plays out. That’s, I think, an interesting theme.
We’ve seen from some of the other infrastructure players, like Kinder Morgan (NYSE:KMI) came out a little bit earlier; their guidance was tempered too.
Magellan (NYSE:MMP), which handles a lot of refined products too, also came out with guidance which is very tempered. So what we’ve seen so far, I think, is an approach where the midstream players are fairly cautious. Especially the ones which handle crude or refined product are more cautious.”
The petrochemical mix will favor some energy infrastructure stocks over others:
“I think that if the inventory levels are supportive, OPEC might look at increasing production.
That is one key thing I’m looking at over the next couple of months, I would say — how OPEC responds to the strength in commodity prices. Do they still keep the production pulled back, or do they say that we’re seeing enough demand recovery to start increasing production?
Then, to the extent they increase production, the U.S. guys will feel a little pressure. So that, I think, is an interesting dynamic that we’ll be looking at in the next few months.
Then obviously, the U.S. LNG space is another one. U.S. natural gas, I think, still provides a way for a lot of economies in Asia to transition to clean energy from where they are right now; a lot of power in Asia is still generated from coal burning.
U.S. gas can provide a very effective mechanism for them to go to clean energy. But we haven’t seen much movement in that direction for new contracts between the U.S. LNG players and international buyers because of the COVID situation. As travel paused a bit, I think that’s an interesting dynamic, also, we will have to watch out for.
The international prices of LNG, which is normally tracked by prices in Asia where a JKM market is one of the most liquid pricing marks for LNG prices, that has strengthened quite a fair bit after the lows we saw in the time of COVID.
I think that provides some interesting backdrop to the LNG situation, so, we’ll have to see how that plays out, too.”
This LNG focus leads to a top energy infrastucture pick for 2021:
“Then the other name I do like is Williams (NYSE:WMB), which is primarily a long-haul natural gas infrastructure player.
They have a consolidated position in the Northeast, a gathering and processing footprint in the Northeast shale plays, so I think they’re also well positioned in the current environment.
They also have made a fair bit of a move towards some of the clean energy ideas that we talked about. They laid out a plan where they will be investing in solar generation, and I think they’re doing it in a mindful manner in the sense that they are integrating it with their existing assets by using solar energy to power the machines which move the natural gas that they are transporting to their customers.
They’re also trying to make a play in the renewable natural gas sector. I think they’re trying to do it in a thoughtful manner by trying to integrate transition of their portfolio to the demand of the new clean energy environment. That’s one of the reasons I do like them, too.”
Get more top energy infrastructure picks and the detailed analysis behind them by reading the entire 3,035 word interview with Sunil Sibal exclusively in the Wall Street Transcript.
David Havens, SMBC Nikko Securities, Managing Director Equity Research
David Havens joined SMBC Nikko Securities in January 2019 in New York as a Managing Director in Equity Research covering the energy sector. Prior to joining SMBC Nikko Securities, Mr. Havens was a senior energy analyst at Deutsche Bank, head of energy research at CLSA Americas, and a senior energy analyst at Citadel Investment Group.
Mr. Havens has 20 years of energy experience, which began at Morgan Stanley in 1999 on the Global Energy Research Team in Houston. In 2005, Mr. Havens transitioned to the Morgan Stanley Principal Strategies Group where he managed an all-asset class energy portfolio.
He holds a Bachelor of Science from the Vanderbilt University School of Engineering.
In this 4,378 word interview, Mr. Havens details the sector’s prospects for 2021 and opportunities for investors.
“I am actually the only U.S. analyst to cover Saudi Aramco.
And then we cover 10 midstream infrastructure players, inclusive of Cheniere (NYSEAMERICAN:LNG), as well as the pipeline guys, the gas processing and fractionation, things of that nature.
My background, I’ve been doing this now for close to 24 years, and I’ve focused exclusively on oilfield services for most of my career, and then I brought on the E&P and the midstream space, so it’s really an across-the-board level of coverage now.”
This experienced oil & gas energy sector professional has recenty become a bull:
“I’m actually quite positive on the sector, more from the perspective of company-specific attributes. Historically, I have actually been one of the larger pessimists on the Street.
I actually, for a period of almost two years, had “sell” ratings on every single stock that I covered, and that was back in 2015 and 2016. My pivot, if you will, is largely based on the fact that you’ve got balance sheets and cash flow outlooks for both the E&Ps and the midstream companies that are going to be substantially better than when oil prices were at $100.
You really have companies that have made aggressive changes: They’ve aligned themselves with the capital discipline that the investment community has called for, and it’s enabled them to have balance sheets that are much more capable of coping with long, drawn-out, deflated oil prices.
But now that oil prices are starting to improve, these models are going to enable them to harvest substantial cash, and they’re going to keep capex budgets lower, so we’re going to see a pivot in positive free cash flow which, frankly, we haven’t seen in this industry in over 30 years.
Obviously, the upstream component of the industry has been notorious for consuming cash.
They’ve never really consistently generated free cash as a group. Obviously, there are a couple of players that have been able to consistently generate free cash, EOG (NYSE:EOG) being one of them. But now that you’ve got a much broader universe of E&Ps that are keeping production flat, which enables them to keep capex budgets low and generate a lot of free cash in the next few years.
So that’s why I say, when you ask about outlook for the industry, I don’t have a tremendously bullish outlook for commodity prices, but I think the companies are simply much better set up to generate free cash in a more moderate oil price environment.”
This outlook leads to specific energy sector stock recommendations:
“…We’ve had the majors, inclusive of Exxon (NYSE:XOM), Chevron (NYSE:CVX), Conoco (NYSE:COP) — we’ve also had Hess Corp. (NYSE:HES) — and they’re generally sticking to the script.
And the script has been, we’re going to keep production relatively flat with the annualized fourth-quarter numbers. We’re going to keep capex generally flattish with the exit rate of 2020. And these were messages that were delivered also in the third-quarter conference calls.
So they’re really sticking to the script, which I think is generally what investors want to hear. They want to see a cash flow generation.
Again, we really hadn’t seen that within the industry in the last 30 years. So it hasn’t been much of a surprise, I think it’s been more of a check the box, we need this to happen.
But this is important, because I think it’s giving confidence, particularly to the long-only community, that you have a very different management style for this next cycle. It’s not all about growth, it’s not all about the ability to produce at a lower oil price versus the next guy.
This is an acute focus on free cash flow generation. So it hasn’t been a surprise as much as it has been just a check the box. This is good; they’re heading in the right direction.”
David Havens also picks some smaller cap players in the energy sector that will leverage free cash flow growth into stock appreciation:
“On the E&P side, it’s going to be Diamondback (NASDAQ:FANG) and Pioneer (NYSE:PXD).
Pioneer is already generating free cash. Pioneer is one of the first to come out and institute a variable dividend structure. So this harvesting of cash flow will be immediately returned to investors. That’s a model that I suspect you’re going see more and more E&Ps down the road begin to adopt — maybe not exactly the same model but a similar type model — to extract dividend returns to investors from the harvesting of cash.
And then Diamondback, a similar type situation. They’re going to be a major pivot in free cash flow in 2021. These are both companies that are very strong in the Permian Basin.
They have some of the best quality acreage. They have some of the best well performance, which is going to enable them to harvest the free cash flow. And at a maintenance capex level, they can maintain production over the next couple of years at relatively flat levels and still generate a tremendous amount of free cash flow growth.
So I think those two are big standouts. Neither one of them has really much exposure to the federal lands issue, so that’s not going to be top of mind with investors for these two companies.
And then on the midstream side a top pick is Cheniere, which is on the LNG side. They’re going to have the most substantial pivot to free cash flow in 2021 within my entire coverage universe, and they’re going to see some of the highest free cash flow growth over the next three years.
I think the LNG sector is probably the single most attractive area of oil and gas globally. You really have a global demand for natural gas phenomenon; you’re able to take cheap gas from the U.S. and move it to the highest-demand regions of the world, which obviously are China and India, but also Southeast Asia.
In aggregate Southeast Asia, China and India represent over 80% of the LNG incremental demand over the next 10 years.
We expect LNG demand to grow at 4.5% a year for the next 10 years. That’s more than double the other growth trajectories, whether you look at just straight dry gas or crude oil demand. So Cheniere is the top pick.”
Get all of David Haven’s top picks in the energy sector and the detailed analysis behind them by reading the entire 4,378 word interview, exclusively in the Wall Street Transcript.
Nina Jones, Portfolio Manager, T. Rowe Price, Real Estate Equity Strategy
Nina Jones, CPA, is the portfolio manager for the Global Real Estate Equity and U.S. Real Estate Equity Strategies at T. Rowe Price. She is also chairman of the Investment Advisory Committee for the U.S. Real Estate Equity Strategy.
Ms. Jones is also a vice president and advisory committee member of the Financial Services and Mid-Cap Value strategies. She is a member of the investment advisory committee of the Global Growth, Global Stock and Institutional Large Cap Value strategies.
Ms. Jones’ investment experience began in 2008 and she has been with T. Rowe Price since 2008, beginning in the U.S. Equity Division. Prior to this, Ms. Jones was a T. Rowe Price summer intern following payroll processor companies in the business services sector.
Prior to joining the firm, she worked at KPMG LLP in the audit and risk advisory area. She received a B.S. degree in accounting and finance from the University of Maryland and received an MBA in finance and economics from Columbia Business School.
In this 3,276 word interview, exclusive to the Wall Street Transcript, Ms. Jones picks out the reboounding Real Estate equity stocks she likes for 2021.
“All of our investing is done on a bottom-up basis using fundamental research. So, during a normal period of time when we can actually travel again, I would get on a plane and visit a lot of the areas where real estate companies own properties.
And you would understand how those locations fit into the broader market. There are locations that are better than others. There are corners that are better. Generally, that’s driven by, like I said, supply and demand.
On the demand side, do tenants want to be in that particular area? A lot of that is driven by demographics. So population growth would be a good one. Also, income of the people surrounding it.
And then on the supply side, can you construct more real estate or is the land scarce? If you have a situation where a lot of tenants would like to be in that particular area, and there’s not a lot of new construction and so the land is pretty scarce — those are areas that we would typically want to be invested in.
We have a significant investment in some of the major cities across the country like San Francisco, New York, Los Angeles, Boston, and Washington, DC. But also, in many of the Sunbelt markets as well, because they’ve had very strong population growth, which has driven good real estate dynamics in those markets as well.”
The global pandemic has highlighted several pockets of value for Real Estate equity.
“…We have significant holdings in both of our funds in industrial warehouses, so I’ll speak about that just for a second before turning to the retail side of things. I do think that warehouse demand will continue to be very, very strong.
As you noted, people want their goods faster. No one is saying I’d like my delivery to come slower. And because of that, industrial warehouses, which are holding these goods, and the tenants of those companies like Amazon need to move closer to the people and that’s what they’ve been doing.
Because of that, a significant part of our funds is in industrial warehouses. We think the demand is very strong.
So can you construct new industrial warehouses? Yes, you can. But that’s typically in the further-out areas of a city where there’s more land.
So if you do own industrial warehouses that are closer in to people, those are getting more and more valuable every day given shortening delivery times. So we continue to really like that as an investment and we have significant investments there.
Now, the flip side of that is obviously we have a lot of retail real estate across the United States and across the world, some of which is declining in value. As you noted, demand for brick-and-mortar retail currently, during the pandemic, has been depressed.
Demand has been pretty weak from tenants to take space. And also, we have a lot of retail real estate across the country already. So there’s kind of a lot of supply so the pricing power is not there for landlords today.
In general, I would say it is definitely a negative that the pandemic has accelerated. We do think though, that for example, grocery stores have continued to have significant traffic during the pandemic, and they are embedded within their local communities.
We still believe that those are important pieces of real estate that are difficult to replicate. So we are more positive on grocery-anchored retail real estate that sits within local communities.”
Real Estate equity stock picks from T. Rowe Price will have their moment in the sun:
“I think now is a good time to invest in the real estate market. The stocks have gone down because of the pandemic.
So your ability right now to invest in very good real estate at reasonable prices is really good. I believe that many of the impacts to demand that we’ve seen have been driven by the pandemic and when the pandemic abates, demand should improve and we should see better results from the real estate companies going forward.
Also, what happens in a recession is that construction slows down and potentially is significantly reduced for the next few years. That will also help a real estate recovery over the next few years as there will be fewer commercial and apartment buildings constructed in the next few years than there were in the past few…
Hotel demand has been severely reduced in the global pandemic.
Again, I think that that is a short-term phenomenon that will bounce back in the next few years. And so I think that investing in hotels today is also very attractive as an interesting opportunity for us as investors…
I do think travel will come back. I think it will come back at a different pace for different types of hotels. So the resorts, and the more local or suburban-type hotels will see demand first and will recover first.
And then later, the more urban properties and group-driven, as you mentioned, convention-type hotels, will recover later.”
Get the Real Estate equity stocks in Ms. Jones’ portfolio and their details by reading the entire 3,276 word interview, exclusively in the Wall Street Transcript.
Brian Demain, Portfolio Manager, Janus Henderson
Brian Demain, CFA, is a Portfolio Manager at Janus Henderson Investors responsible for co-managing the Mid Cap Growth strategy, a position he has held since 2007.
Mr. Demain joined Janus in 1999 as a research analyst focused on companies in the media and communications sectors. From 2004 to 2007, he led the Communications Sector Research Team.
Mr. Demain received a degree in economics from Princeton University, graduating summa cum laude, and was elected to the Phi Beta Kappa honor society.
In this 3.053 word interview, exclusively in the Wall Street Transcript, portfolio manager Brian Demain advocates firmly for his top picks.
“I can talk about Microchip (NASDAQ:MCHP) which is a name we’ve held for a while.
Microchip is a leading provider of microcontrollers. If you think about an Intel or AMD chip as sort of a central processing unit for a computer, your control unit for a computer, microprocessors basically kind of do what those chips do on a much smaller scale. So in your garage door opener or your coffee machine or your climate control system in your car.
What we like about Microchip relates to our investing framework. We talk about sustainable growth.
So the semiconductor industry has grown at a healthy clip for the last 40 years and we think it grows at a healthy clip for the next 40 years. That’s a function of just broadening use cases for semiconductors, whether it be industrial or Internet of Things — semiconductors being used in new cases in medical, in automobiles, in artificial intelligence and the like. Artificial intelligence needs semiconductors behind it.
And so Microchip kind of rides the growth tailwinds of that semiconductor industry and it’s been a consistent share gainer within the microcontroller space by virtue of having a very focused business model and strong loyalty from their customers.
So we see the opportunity for the company to grow for a very long period of time.
When we think about the company’s competitive position and returns, we see a company that currently operates at high-30s operating margins that we think can actually go a little bit higher.
It’s a very capital-efficient business model. So returns on capital are strong. And we think their competitive position is strong and getting stronger.
What happens in the microcontroller world is, when you’re designed into product, the product life cycles are very long. So when you’re putting a chip inside of a server, you’re always looking for the next fastest chip.
If you’re putting a chip inside a small appliance, once you’ve designed it in and it works, and the price point is right, it’s generally kind of left in that product for a very long lifecycle. So we have a strong sense that they’ll be relevant and important competitively for the long term.
And then, we consider the strength of a company’s management team and Microchip has been led by Steve Sanghi for 27 years as CEO of the company.
He’s actually retiring and turning it over to his COO, who’s been at the company for a very long time as well, and sort of been his right-hand man. It’s a team that’s led this company for a long time, and very successfully focused on balancing the needs of shareholders, employees and customers, and has done that successfully. So we really believe in the management team.
And then, from a valuation point of view, Microchip trades at around 20 times out-year earnings, on a more normalized post-COVID basis.
And our view is that we can buy a company that we think can compound its top line at a 6% or 7% clip, and generate a lot of cash flow as it grows.
To pay a 20-times forward-earnings multiple for that profile is very sensible. And so we see a situation with Microchip where the recipe is in place for long-term value appreciation.”
Brian Demain also sees the trend towards electric vehicles as a plus for Microchip:
“I think with a lot of these microcontroller and analog semiconductor companies, one of the more exciting things to pay attention to is the rise of electric vehicles.
If you look at the semiconductor content in a car today, I think it’s around $600 and that’s up dramatically from where it was just five years or 10 years ago.
But if you think about switching from an internal combustion engine to an electric powertrain, you will then see the amount of semiconductor and connector content take another dramatic step higher.
You’re effectively replacing the engine with the battery. There’s a lot of semiconductor intelligence around that system to control the battery and the like.
As we have an economic recovery coming out of COVID, we’ll see auto production rise. And as that happens, that’s a good tailwind. Then you layer on share shift from internal combustion to electrification and that will lead to faster growth for these companies.
And so we own Microchip.
But we also own several other semiconductor companies that benefit from this move to electrification. What’s interesting about participating in this through the semiconductor value chain is you don’t have to pay the multiples that you’re paying for in some of the more obvious electric vehicle players.
These companies are still valued on earnings, but we think their earnings growth will accelerate as a result of the electrification of the auto fleet.”
The continued growth rate is supported by Brian Demain’s analysis:
“…If you look historically, midcap companies have actually outperformed both small and large caps over the long term.
That’s been a function not of a valuation expansion of midcaps relative to small and large caps, but rather a function of midcaps growing their earnings faster.
I think it’s not that surprising that midcaps have grown their earnings faster than large caps because the large-cap businesses, maybe with the exception of a few of the big platform tech companies, are generally going to be in a more mature state than the midcaps.”
Get all the top picks from Janus Henderson portfolio manager Brian Demain by reading the entire 3.053 word interview, exclusively in the Wall Street Transcript.
