Q1 Picks From Arlington Value - Concentrating On The Best Ideas

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Includes: LTRPA, MCO, RAVN, TRIP
by: Safety In Value

Summary

New position Raven Industries has quality businesses in out of favor industries.

New Position in Moody's - a long-term moat business.

Added to Berkshire and other existing positions.

Arlington Value is the concentrated value fund run from Utah by Allan Mecham. The fund is highly concentrated, with positions in only 15 companies at the end of Q1. That concentration makes the funds positions a strong expression of Mecham's opinions. This is especially true as he tends to have very low turnover in the portfolio, so a new buy is likely something he feels strongly about for the long haul.

Of course, a concentrated portfolio increases the variability of returns to both the upside and downside, so it isn't really appropriate for most investors. That is especially true considering the leverage used within the hedge fund structure.

Nonetheless, it can be instructive to look at the buys and sells of respected investors to look for ideas for our own portfolios, as long as we remember to make sure to do our own work. It is especially important to understand why you're buying something, as that will inform your view on what to do if something changes in the situation.

NAME OF ISSUER Symbol Value ($000s) Shares at Year-End 2015 Shares at end of Q1 2016 Shares Purchased in Q1 2016
BERKSHIRE HATHAWAY INC. CL A BRK.A 9,178 43 43 -
BERKSHIRE HATHAWAY INC. CL B BRK.B 190,290 1,060,090 1,341,210 281,120
CHEFS' WAREHOUSE HOLDINGS LL CHEF 10,402 666,154 512,706 - 153,448
CIMPRESS N V CMPR 197,194 2,364,305 2,174,376 - 189,929
COPART INC. CPRT 4,354 114,538 106,809 - 7,729
DESWELL INDUSTRIES INC. DSWL 171 100,981 100,981 -
HEICO CORP. NEW - CL A HEI.A 1,430 29,261 30,061 800
INTERACTIVE BROKERS GRO-CL A IBKR 74,944 1,830,685 1,906,006 75,321
LEUCADIA NATIONAL CORP. LUK 103,656 4,686,991 6,410,447 1,723,456
LIBERTY TRIPADVISOR HDG-A- LTRPA 740 33,438 33,438 -
MOODYS MCO 24,422 252,928 252,928
MSC INDUSTRIAL DIRECT CO-A MSM 72,493 1,190,925 949,985 - 240,940
NOW INC./DE DNOW 83,824 6,086,623 4,730,512 - 1,356,111
OUTERWALL INC. OUTR 29,222 1,386,001 790,024 - 595,977
OUTERWALL INC. (Calls) OUTR 1,616 55,200 43,700 - 11,500
RAVEN INDUSTRIES RAVN 343 21,439 21,439
SONY CORP. - SPONSORED ADR SNE - 1,331,635 - 1,331,635
TRIPADVISOR INC. TRIP 13,245 324,040 199,185 - 124,855
Click to enlarge

With that being said, on to this quarter's updates. You can see all changes and the full portfolio in the table above. My previous article covered the opening of a position in the Liberty Tripadvisor and Tripadvisor . The Tripadvisor position was reduced this quarter, while the LTRPA position was maintained. If Mecham was reducing exposure to the operating business, it makes sense to keep the Liberty Tripadvisor shares, as they are trading at a material discount to the TRIP shares they represent.

Raven Industries

One completely new position in the portfolio this quarter is Raven Industries. The company is a mini-conglomerate of sorts, with businesses making precision farming equipment, engineered films, and their Aerostart business, which makes balloons, parachutes, aerostats, etc.

The agriculture business is in a cyclical low due to commodity prices, as is the engineered films business (which services the oil and gas industry). The Aerostart business is the one with the most blue sky upside potential, as the company has partnered with Google on a plan to use high altitude balloons for telecommunications. That's very much a long-shot, although if it works it would likely be extremely valuable to the company. Nonetheless, I would only be interested in buying if I could get that as a free option.

The market consensus on Raven is pretty dour, with the 31% off its 52 week high at its current price of $15.30. There appears to be some solid rationale for this decline, further explained in this short thesis from SA Author The Geoteam. One quote from the article and the company's guidance stood out to me.

'As we begin fiscal year 2017, the markets served by our core businesses remain very challenging,' said Rykhus. 'The precision agriculture market is expected to decline for the third straight year, oil and gas prices are suppressing drilling activity, and defense spending continues to be curtailed. This is not the ideal backdrop for a business with our end market exposures…'

When the view of management and everyone else is that the end markets of a business are challenging, there are only two possibilities: either the business is permanently impaired or the markets are near a cyclical low. Since food (and thus precision farming) seems unlikely to go out of style, I suspect that market is not permanently impaired. Oil and gas is a bit tougher, but I think there's probably at least one more up-cycle for that industry before its products get replaced by renewables.

Defense spending is tougher for me to quantify, although the world doesn't seem like its getting more peaceful (and humanity doesn't have a great track record on that) so I suspect selling military goods will also turn around at some point. Of course, the fact that none of the end markets are doomed (this isn't Blockbuster Video) doesn't necessarily mean the company will find success, as they will still face competitors in all markets.

The company doesn't appear cheap by any normal metrics (P/B and P/S are both ~2, and P/E is very high on depressed earnings). That being said, it does appear to be a company with quality businesses (I especially like precision agriculture) at a cyclical low, which is Mecham's specialty.

Moody's

Moody's will probably need no introduction for many readers, as it is one of the three main raters of debt (along with S&P and Fitch). The services of these companies are essentially required for anyone wishing to access bond financing from the capital markets, which provides the company a durable moat. And because its primary product is information, the company is very capital light. For more on the company's moat, see here by Mark Dockray.

If we accept that the company has a durable moat, whether its a good purchase or not always comes down to price. The company has a 52 week high of $113, and is currently trading at $94 for a 21X price to earnings ratio. The company has been buying back shares fairly materially (~4% reduction in outstanding in 2015), which should allow them to continue growing EPS into the future, even if profits merely stay steady.

Speaking of entrance pricing, I'm not privy to what Mecham paid for the shares, but they did trade below $78 in the quarter. I have to wonder whether the sales (discussed below) in the portfolio were to take advantage of the Q1 "sale" in Moody's and Berkshire Hathaway. Mecham also bought BRK.B in the quarter, adding materially to an existing position.

Sales and Other Notes

The fund also made a number of sales during the quarter, including the entire position in Sony. Mecham also trimmed his positions in distributors, which has been a theme of the portfolio lately. Reductions in this area included DNOW and MSM, both of which have oil and gas exposure in various ways. I also think the addition to Leucadia is interesting, as it doesn't fit the wide moat/quality business theme (in my opinion), the thesis there is more a sum-of-the-parts one.

Mecham's portfolio is always interesting, and this quarter had two new positions, which is on the high side for him, suggesting that he saw value in the markets in Q1.

Disclosure: I am/we are long IBKR.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.