Viking Supply Ships

Summary: Viking’s equity has limited downside, 45-80% upside, and a hard catalyst to realize value in the next few weeks.

Viking is listed in Sweden and announced on Aug 10 that they had sold 3 of their vessels. We estimate this was for a price of roughly $380mm. The company has net debt of $203mm and a market cap of $193mm meaning that the cash from the sale will be enough to repay all of the company’s outstanding debt and pay a special dividend equal to almost the entire market cap. In addition, the Viking stub will still own 4 high quality vessels that are in total likely worth $175mm at replacement value, or 60% of that in the event of an immediate liquidation. The stock therefore has limited downside and 45-80% upside. This opportunity exists because only 21% of the stock is floating and mostly owned by retail investors. The market cap was just $27mm prior to the sale and has rallied 715%, which has sparked a round of profit taking. The remaining 79% of the company is owned by a Norwegian investment firm that reported on Aug 22 they expect a special dividend when sale of the 3 vessels closes (at the end of August). This hard catalyst means that Viking offers 45-80% upside but an even more compelling IRR.

Standard Drilling

Full article here.

Summary: Standard Drilling is a $127mm market cap company that trades only $150k per day on the Norwegian stock exchange, has no earnings, and is only covered by Norwegian sell-side. The company was set up 2 years ago by a successful Norwegian investor to acquire oil supply vessels from distressed sellers who had taken on debt to order vessels at peak cycle. Extensive primary research reveals that these vessels are worth double Standard’s market cap, that the cycle bottomed a few months ago and is turning, which could quickly act as the catalyst to close this valuation discount. There is only 27% downside even if bottom of the cycle vessel values persist forever.

Update on The US Shale Industry

Full article here.

This is an update to a Jan 2017 report published by Plural explaining why we are short US shale oil producers. Since then, the S&P oil & gas exploration and production index has fallen 21% and the Plural strategy has gained 628bps in portfolio return from energy positions while maintaining a portfolio beta to oil of -0.03.

Based on our primary research and analysis we continue to think that shale oil producers located predominantly outside of the Permian basin do not have viable business models. We think that most producers are destroying value for shareholders and will continue to do so as they are the marginal cost producers in the global oil markets. In our opinion, the lower costs of Permian producers will ultimately force other basins out of the market. As production and infrastructure gets built out, the winners will likely be consumers and service providers. We identify four factors that differentiate companies: geology, geography, capital structure, and management. We are short 5 mostly non-Permian companies – Chesapeake Energy, PDC Energy, QEP Resources, SM Energy, and WPX Energy – and admire EOG Energy.

Air Lease Corp - Short Position

Summary

ALC is an aircraft lessor that is very well liked by the investment community, with 12/13 analysts on Reuters giving Buy ratings. Analysts like that aircraft leasing is a structurally growing sector which they believe has stable yields and stable growth for ALC. Yet our industry contacts reveal that the Street is completely missing a game-changer for the industry: the entry and growth of Chinese lessors. In addition, western institutions like pension funds and insurance companies are entering the market. These new players have significantly lower costs of capital than ALC, and are forcing lease rate factors down. In a world where interest rates are close to zero, aircraft leasing still often earns double-digit yields, and this is now changing. The swarm of new money has also significantly increased the supply of planes. Given the cyclicality of the airline leasing industry, this is likely to lead to major impairments and even lower lease rate factors at the next downturn, which may already be beginning. Lastly, leases to Chinese government owned airlines account for ~20% of ALC’s revenues, and these carriers may choose to switch to the Chinese government owned lessors in the future. As one industry source told us when we asked how ALC could stay competitive versus the new players: “Good question … How do you make money when nobody is making any money?”

US Shale: Why US shale producers are drilling into oblivion and have no way out

Full paper here.

Abstract

The last five years has seen capital poured into the US shale sector, leading to explosive growth in oil and gas production. This report argues that shale producers are mostly destroying value regardless of commodity prices, because they are the marginal cost players in their industries. Even those operating in the lowest cost basin, the Appalachian basin, are not an exception to this. In fact, Appalachian gas producers be exposed to the worst dynamics as they effectively compete against one another locally and the influx of capital has led to a large oversupply of gas in the region. Even if managers of shale producers realise their predicament, they are faced with the choice of either reducing value destructive investments and seeing the story of production growth fade back to reality, or continuing to invest and hoping in vain that the music never stops. They are thus drilling into oblivion and have no way out. A list of companies that are fundamentally losers and winners is presented at the end. 

Why plural investing?

What is ‘plural’ investing?

Most investment funds follow one of two ‘singular’ approaches:

  • Systematic: automated computer systems that invest based on rules.
  • Discretionary: human investors who choose what to invest in.

A ‘plural’ approach combines systematic and discretionary elements into a process that is greater than the sum of its parts. It does this by having these two elements cooperating in a way that amplifies their strengths while reducing their weaknesses. This requires constant cooperation between them and the human investor to understand how and why the system is making its recommendations.

Lessons from chess

“Weak human + machine + superior process was greater than a strong computer and, remarkably, greater than a strong human + machine with an inferior process.” – Garry Kasparov

Chess was one of the first games where a ‘plural’ process combining machines and human players was shown to be superior to machine-only and human-only. It turns out the cooperation between man and machine was the key to this success:

In 1997 the world chess champion, Garry Kasparov, was defeated by a computer system, IBM’s Deep Blue. After his defeat, Kasparov introduced ‘freestyle chess’, in which competitors can enter as a human player, a computer program, or a ‘plural’ player – a human player working with a computer which suggests moves.

Chess computers were far superior to human players, but when the first major tournament was held in 2005 all four semi-finalists were ‘plurals’, not computer-only players. Three were teams of grandmasters and supercomputers, but the winners were two amateur chess players choosing moves from three consumer grade computers.

They won because they considered moves from several computer systems, understood why these systems recommended them, why the recommendations might be different, when these systems would be strongest, and the strengths and limitations of themselves. This allowed them to select better moves than a grandmaster using one supercomputer.

The two key conclusions are that not only does a ‘plural’ process get the best results, the best processes have systems and humans cooperating in a way that gets the best out of both.

‘Plural’ processes are even more useful in investing

Like in chess, in investing computer systems can download or recall data and process it exceptionally quickly and rationally. But they struggle to adapt, think or be creative. They are therefore strong at making a wide range of analysis but weaker in their depth of analysis.

On the other hand, human beings are very limited by the speed they can ‘download’ data, process slowly and are emotional. However, our ability to think often enables us to make deeper analyses. Unlike in chess, humans also have access to valuable data that machines don’t because we can consider more qualitative data and can proactively look for unique sources of data for every investment idea.

The aim of the ‘plural’ process is to maximise both the range of data and the depth of analysis.

How we maximise the cooperation effect

Our investment process involves an alpha model, portfolio construction model, and human investor cooperating in a way to bring out each other’s strengths rather than weaknesses:

1) The alpha model analyses every stock in our universe. It considers objective data, but also subjective data create by the human investor. This focuses the human on acquiring knowledge (data) and the model to weight it up. The human investor uses his understanding of the model to exclude long/short recommendations where the it was unlikely to have considered significant external variables, such as takeover speculation, changing politics, and the launch of a game-changing product.

2) The remaining ideas are placed into a portfolio construction model that uses machine learning techniques to ‘learn’ which are most attractive in a portfolio. This effectively recommends less correlated ideas. Once again, the human investor prunes these recommendations.

3) The human investor now conducts in-depth analysis. The primary aim of this is to do analysis that the machine cannot and to understand why the human’s conclusions are different to the machine’s. This results in the human investor’s estimated risk and reward values.

4) These are added to both the alpha model and portfolio construction model. As human investors tend to be too optimistic about expected reward and too pessimistic about expected risk, the models shrink the human’s estimated rewards and grows the estimated risk. They use simulation and machine learning techniques to arrive at several final recommended portfolios. Importantly, the human investor can now see why different recommendations disagree, and ask the model to look more closely at certain scenarios. Finally, he builds a plural portfolio.

Smart engagement needed: Why low-cost European airlines are good businesses and WIZZ is undervalued by 178%.

For full paper click here.

Abstract

There has long been a stigma attached to investing in airline stocks. Yet a group of Low- Cost-Carriers (LCCs) have emerged in the European short-haul market over the last decade that have significant cost advantages over legacy High-Cost-Carriers (HCCs). These cost advantages are on fuel, crew, and maintenance, and stem from having more homogenous and modern fleets, weaker worker unions, profit-maximising cultures, and greater utilization. We think these sources of competitive advantage enable them to generate value and are largely durable. The greatest risk LCCs face is from being victims of their own success: overexpansion could push HCCs out of the market and result in much lower prices and profitability. However, we think it is more likely that the largest players will continue to behave smartly and nurture the market. While supernormal returns may shrink over time, LCCs will remain good businesses. We think that Wizz is the LCC with the greatest durable cost advantage and the cheapest stock, and see +178% equity upside when using a conservative valuation model. We think the market misprices Wizz because it is overly focused on short-term pricing pressure, Brexit, still de-stigmatizing LCCs, and is still getting to know it post the IPO in 2015.