Ensemble Fund Investor Letter – First Quarter 2019
Below is the Q1 2019 quarterly letter for the ENSEMBLE FUND (ENSBX). This quarter’s Company Focus is on Landstar Systems, Inc. (LSTR) and Alphabet, Inc (GOOGL). You can find historical Investor Communications HERE and information on how to invest HERE. Enjoy!
The performance of the Ensemble Fund (“the Fund”) this quarter was strong, showing a sharp reversal in both absolute and relative performance compared to last quarter. The fund was up 17.39% vs the S&P 500 up 13.65%.
As of March 31, 2019
|1Q19||1 Year||3 Year||Since Inception*|
*Inception Date: November 2, 2015
Performance data represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than the performance data quoted. Performance data current to the most recent month end are available on our website at WWW.ENSEMBLEFUND.COM.
Fund Fees: No loads; 1% gross expense ratio.
The strength in our equity strategy during the quarter was supported by positive returns from every stock in our portfolio with notable 30%+ moves from Netflix (6.4% weight in portfolio), Ferrari (8.4% weight in portfolio), TransDigm (4.9% weight in portfolio), and Tiffany (4.0% weight in portfolio) and 20%+ rallies in Mastercard (7.3% weight in portfolio), Paychex (5.0% weight in portfolio), Trupanion (2.3% weight in portfolio), Fastenal (2.8% weight in portfolio), and Verisk (3.2% weight in portfolio). On the weaker side we saw low single digit gains in Sensata Technologies (5.4% weight in portfolio), Charles Schwab (4.6% weight in portfolio), and Booking Holdings (7.3% weight in portfolio).
While over the medium to long term our investment returns are primarily driven by security selection and the individual corporate performance of the companies in our portfolio, the dominant driver of our strategy’s performance over the last two quarters has been shifts in market expectations around economic growth. We have been relatively overweight to more economically sensitive names for much of the past few years due to these types of stocks generally being relatively inexpensive in our view, while more economically defensive companies have seen their stocks trading at historically rich valuation. This led to our portfolio exhibiting more downside than the market as recession fears became pervasive in the fourth quarter and to strong outperformance this past quarter as market action was driven by the idea that recession fears had become overblown and decent economic data was reported.
The rally in Netflix was primarily driven by a general reversal of the downside that many higher volatility stocks saw during the fourth quarter. However, Netflix also reported another strong quarter of new subscriber additions and, very importantly, they announced a large price increase. Netflix strikes some people as an atypical investment for Ensemble. With its very high PE ratio on current earnings there is a general perception that it is more of a momentum play than a long-term cash generation machine of the type we seek. But we believe that Netflix is building a dominant global media company and, importantly, they are currently intentionally underpricing their service as part of a strategic plan to build a subscriber base well in excess of any competitor. While we have yet to see how it impacted first quarter subscriber growth, the almost 20% price increase on the heels of high single digit price increases in recent years demonstrates the strong pricing power both we and the company believes they have.
The rally in Ferrari was supported by the company’s earnings report in which management said that they had not seen any unexpected impacts to their order books as a result of the recent global market volatility. While it seems obvious that an entirely discretionary product like a Ferrari would see significant weakness in demand during recessions, historically Ferrari has been the most recession resistant automaker. Due to the long wait list to buy a Ferrari and the fact that the vast majority of Ferrari buyers can still afford a Ferrari even in the midst of a recession, the company does not see the sort of drop off in sales that most automakers experience during periods of economic weakness.
TransDigm’s rally was particularly satisfying for us. Back in early 2017, a well-known short seller accused the company of a wide range of bad behavior that focused on defrauding the Department of Defense via overcharging them for the company’s spare airplane parts. After extensive diligence on our part, we concluded that these accusations were wrong. After a near 25% decline in the wake of the short report, the stock has more than doubled in the past two years. During the last quarter, the Office of the Inspector General, that had begun auditing the company’s sales at the request of two politicians who were sent the short report, concluded their work. While the audit found that TransDigm earns very high profit margins on their sale of aftermarket parts to the Department of Defense, it did not find any wrongdoing and it supported our view that sales to the Department of Defense were done at similar pricing to what commercial airlines pay. As the sole source provider of low-cost parts that are required to be replaced on set schedules by the FAA, TransDigm earns very strong profit margins and returns on capital. But that does not mean they are overcharging their customers. While the Office of the Inspector General recommended that the military begin requesting much more stringent cost information even for low priced products, the Department of Defense has been moving in the opposite direction in recent years as they attempt to streamline purchasing of low-priced products so that they can efficiently ensure a fully operational air force.
The weak rebounds in Sensata, Schwab and Booking each had company specific drivers. With Sensata, the ongoing threat of tariffs on autos has been a persistent concern. These potential tariffs are not just related to the US-China trade war, but also to efforts by the Trump administration to deem imported autos as a national security concern and thus allow for tariffs to be imposed on foreign automakers, including those of key allies of the United States, in ways that would otherwise violate trade rules. But we would note that Sensata sells sensors to every global automaker of note meaning that so long as cars are being bought, it doesn’t really matter to Sensata which country they are being made in.
Schwab continues to gather client assets at an astounding rate. However, as we detailed on last quarter’s call, Schwab’s profit model has shifted towards their interest rate sensitive bank, so the recent declines in interest rates and flattening of the yield curve will limit the company’s near-term earnings power.
While investors have been negative on Booking for much of the past year, we would note that far from seeing their growth rate crumble, 2018 saw high teens revenue growth and EBITDA growth. Their guidance for Q1 was somewhat disappointing. However, when viewed on a currency neutral basis and accounting for Easter travel bookings falling into Q2 rather than Q1 this year, given the holiday falling in late April rather than late March, we think the company is continuing to see solid core demand trends. Although they are seeing some weakness in Europe, their largest market, it appears that much of that weakness is due to uncertainty related to Brexit, potential auto tariffs hurting the German economy, and protests in Paris. As those issues come to a resolution, we would expect demand in the EU to continue to be fine and would point out that Booking’s strong growth over the last decade has occurred within the context of a weak Europe economic environment.
Last quarter we wrote about the rising risk of a recession; where we discussed our outlook for equity markets and framed it by listing three primary outcomes:
- If no recession occurs: The stock market will likely generate very strong returns over the course of the next couple of years.
- If a mild recession occurs: With the stock market already selling off by the magnitude that would typically be associated with this outcome, there may be limited downside even if things play out this way. (To reiterate, this is what we said last quarter, prior to the recent large rally)
- If a severe recession occurs: In this event, there may be considerably more downside for US equity investors.
Investors should consider the investment objectives, risks, and charges and expenses of the Fund carefully before investing. The prospectus contains this and other information about the Fund. You may obtain a prospectus at www.EnsembleFund.com or by calling the transfer agent at 1-800-785-8165. The prospectus should be read carefully before investing.
An investment in the Fund is subject to investment risks, including the possible loss of the principal amount invested. There can be no assurance that the Fund will be successful in meeting its objectives. The Fund invests in common stocks which subjects investors to market risk. The Fund invests in small and mid-cap companies, which involve additional risks such as limited liquidity and greater volatility. The Fund invests in undervalued securities. Undervalued securities are, by definition, out of favor with investors, and there is no way to predict when, if ever, the securities may return to favor. The Fund may invest in foreign securities which involve greater volatility and political, economic and currency risks and differences in accounting methods. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. More information about these risks and other risks can be found in the Fund’s prospectus. The Fund is a non-diversified fund and therefore may be subject to greater volatility than a more diversified investment.
Distributed by Rafferty Capital Markets, LLC Garden City, NY 11530.
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The information contained in this post represents Ensemble Capital Management’s general opinions and should not be construed as personalized or individualized investment, financial, tax, legal, or other advice. No advisor/client relationship is created by your access of this site. Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. If a security discussed in this blog entry is owned by clients invested in Ensemble Capital’s core equity strategy you will find a disclosure regarding the security held above. If reviewing this blog entry after its original post date, please refer to our current 13F filing or contact us for a current or past copy of such filing. Each quarter we file a 13F report of holdings, which discloses all of our reportable client holdings. Ensemble Capital is a discretionary investment manager and does not make “recommendations” of securities. Nothing contained within this post (including any content we link to or other 3rd party content) constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instrument. Ensemble Capital employees and related persons may hold positions or other interests in the securities mentioned herein. Employees and related persons trade for their own accounts on the basis of their personal investment goals and financial circumstances.