In this article I analyze John Burbank's Passport Capital, a $4.6 billion long/short hedge fund. According to HedgeFundLetters, Passport identifies several macro-trends then utilizes a bottoms-up value orientation for security selection within his top-down analysis. I got Passport's portfolio via Gurufocus. I think it is important to analyze key holdings from prominent fundamental-oriented hedge funds because hedge funds have more resources to analyze stocks than the majority of individual investors. Let's analyze Passport's most interesting stock selections:
Yelp: Passport is bullish on this Internet pick
Passport recently initiated a position in Yelp (YELP). You can see Passport holdings in this link. In a recent conference, John Burbank explained that he likes Internet companies operated by management teams that are aligned with shareholders' interests. Passport seems to think that Yelp is one of those.
Yelp is the largest local search and user-based review platform and operates like a search engine in which users look for recommendations about a restaurant or store in almost any U.S. city. I believe there are three factors that will drive earnings growth in the future:
- geographic expansion,
- leverage from sales operations, and
- monetizing the mobile experience.
In terms of geographic expansion, the company is focused on launching its platform in several international markets. In the first nine months of 2012, it launched in 18 international markets, including Helsinki and Singapore in the third quarter, increasing its worldwide markets to a total of 96. In the last three months, it started operations in Poland, Denmark, Norway, Finland, and other European markets. As Yelp continues to move into additional new markets, it should experience a significant increase in its local advertising revenues, which will drive earnings growth.
The company is also focused on exponential growth, which is evident in recent reported growth metrics. In the last quarterly report, Yelp showed strong 4Q FY12 results, driven by impressive core local ad growth of ~80% year/year. In addition, Yelp reported that 25% of local ads were shown on mobile devices in 4Q and that 30% of its unique visitors come through mobile platforms. I believe that the Yelp model lends itself well to the mobile opportunity as mobile amplifies the local opportunity of the Yelp platform. In other words, a great mobile platform allows Yelp to offer real time deals, Foursquare-like check ins, real time recommendations, etc. These are offerings that the PC experience cannot match.
To summarize Yelp's impressive 4Q growth metrics:
- Cumulative reviews grew 45% year over year to more than 36 million at the end of 2012.
- Average monthly unique visitors grew 31% year over year to approximately 86 million.
- Active local business accounts grew 68% year over year to approximately 39,800.
- Adjusted EBITDA for the fourth quarter of 2012 was approximately $1.8 million, compared to an Adjusted EBITDA loss of $15,000 for the fourth quarter of 2011
Yelp is focusing on leveraging its growing user base via its mobile app. I think that Yelp is becoming a "quasi-search engine" as users prefer Yelp over other search options, when it comes to reviews and local recommendations.
Considering that Yelp currently does not run any ads on its mobile app, it is reasonable to expect significant revenues from the mobile app in the future as Yelp finds different ways to monetize it.
Stocks levered to the improving U.S. economy
Cytec achieved record growth in 2012, with full-year sales increasing 13% versus the prior year. The top line growth came from strong demand for Cytec products across the mining sector, as the company penetrated new geographies taking advantage of CYT's unique separation technologies. In addition, CYT's sales growth also was complemented by pricing improvements, which altogether led to record operating earnings for the year of $91.8 million, a 32% increase versus 2011. These improvements led to strong operating margins of approximately 24%, another record achievement for this business. Cytec's investment thesis is simple: as the U.S. economy keeps recovering and emerging markets growing, Cytec will keep delivering improving results. Passport seems to be extremely bullish on this concept.
- Operating margin of 8%, which is the highest operating margin of the past 10 years
- ROE of 20%
- EBITDA growth of 35%
- Revenue Growth of 9.5%
- Forward P/E of just 10x and Earnings Yield of 12
In addition, Huntsman generated over $200 million in cash from operations. At the moment, Huntsman is seeking to reduce debt and repaid $50 million of term loans in the Q4.
To sum up, HUN is a company that combines an inexpensive valuation with strong potential growth. Its overall fundamentals are expected to improve as the company reduces debt.
Picks in the energy sector
Passport increased the position in Kinder Morgan Inc. (KMI) last quarter. Kinder Morgan has been increasing cash distributions on a consistent basis and plans to transform into a pure play MLP general partner company. As a result, KMI will continue increasing dividends and considering it has a strong business model and immense presence in the market, it should reward long term investors.
The fund also bought Williams Companies (WMB). According to a Scout Capital presentation I read from MarketFolly, WMB should be valued using a sum of the part model, which gives a base case price of $37 and a bull case of $47-50.
Scout Capital assumes the following valuations in its base case (source: marketfolly):
- Infrastructure assets. Dividend of $1.14-1.37, 1.2x coverage, gets $25 stock based on 4.5% yield, similar to KMI or OKE comps. Upside case 4% yield is $30.
- E&P business: $9.00 floor share, based on NAV comps- CHK, et al. $1.24 per proven mcf, 25% below peers.
- Hidden asset. Canadian Midstream business, oil sands gas processor. Based on 4.5x EBITDA get $3.00 base case, upside based on dividends, 0.40 div, 4.5-5.0% yield, get $6-8 per share in bull case.
- Balance sheet value/ cap structure optimization. Either M&A or buyback, get $2-3 per share.
Barclays is also bullish on WMB as the company continues its high-dividend-growth strategy post-2013.