31 Oct 2017

Super cheap Boom

“Thinking creatively about the future, rather than unimaginatively extrapolating from the past is also the key to capturing the value of change.” Ed Lam, Somerset Capital, Portfolio Manager

We have been long term followers of Ed’s monthly commentaries. We find them useful because of his well-reasoned contrarian views, and he invariably broadens our vocabulary. This month’s word was excogitation, I’ll leave you to Google that! The above quote from Ed this month is an excellent encapsulation of why long-term investing works so well. In our, and Ed’s, opinion the market has a serious tendency to extrapolate the recent past into the future. This extrapolation creates some fantastic value opportunities when the market sees bad news as the new status. This can lead to companies becoming cheaper than even the most pessimistic value investor believes possible. The corollary of this is that value investors often buy too early. Something our Ranger Fund suffered from in 2015.
 
However, as time progresses there is an interesting inflection point with value stocks where the market starts to question whether the bad news might be abating. This stage of the value opportunity can see a significant re-rating of the stock price from this shift in sentiment, but even with this re-rating the stock price can still be at very depressed levels as investors then wait for proof via positive trading statements and earnings results.
 
Recently the Ranger Fund has benefited from some of our value positions appearing to reach this inflection point. This year two of our Mining Services companies, Macmahon Holdings and Boom Logistics, have appreciated significantly, up 145% and 81% respectively. At a fund level they explain 11% of the 21% return that the Ranger Fund has delivered year to date. But just as importantly they are also a big part of why we remain confident in the ability of the fund to continue to deliver positive returns in the medium and long term. We still see significant upside in their share price. They have merely gone from extraordinarily cheap to super cheap.
 
Take Boom Logistics for example, which we first purchased in the second half of 2014. We detailed the investment case in commentaries at the time. Basically, we purchased shares at a level which meant we got the assets of the business at less than 50% of their heavily written down value. The average entry cost at that time was around 16.5c a share. Our belief was that buying and holding those shares for the three to five years would generate returns well in excess of 100%. We were early. The shares continued to fall for the next two years and in May last year they were trading as low as 6c! The market had completely given up on any notion that the business could return to profitability. Boom had become extraordinarily cheap. We did take advantage of this extreme pessimism to purchase more shares but we were clearly not making positive returns on the investment at that stage.
 
Slowly though the negative news flow began to abate. As 2016 progressed, investors started to once again contemplate the possibility that Resources and Mining Services businesses could make a half reasonable return on their capital. This was a slow thawing that started with the larger resources stocks and eked wider over time to the larger Mining Services names. And then finally last month it reached Boom. It began September trading at 10.5c and finished the month at 17.5c. A strong monthly return but one that merely elevated it back to the status of super cheap. Just about where we first purchased it three years ago with a target of over 100% return within the next five years. We still have that view and having passed a news flow inflection point we are increasingly optimistic about the continued contribution that Boom and our other Mining Services positions can make to the Ranger Fund.