HVG Q3 2024 Portfolio Review

15 October 2024

HVG portfolio returned +6.8% in the past quarter and +16.2% in the first nine months of 2024. This performance is within my historical objective of generating 10-20% returns through the cycle and my recent ambition to achieve over 20% returns by selectively adding smaller, less-covered stocks.

The portfolio follows the barbell strategy with a strong foundation of low-risk businesses such as Berkshire Hathaway, Exor and Loews, complemented by a handful of high-risk/high-return investments. The first group acts like an anchor during the storm, while the second group adds critical growth and valuation re-rating potential. Rebalancing between the two groups is another essential element of the strategy. For example, in a downturn, the share of riskier investments in the portfolio will decline (as they fall more than the defensive names), which provides an opportunity to increase exposure to this riskier group at lower prices using relatively more expensive defensive stocks as the funding source.

There are two goals HVG aims to achieve.

Firstly, to own great businesses priced at a discount, benefiting from returns on capital that these businesses generate with an additional upside coming from potential share price re-rating. Secondly, to avoid heavy losses and to have flexibility to increase investments during market turbulence.

To achieve the second goal, I keep a high weight of low-risk companies with strong liquidity (almost 60%) and an extra cash (6% weight at the end of Q3 2024).

Such an approach inevitably leads to underperformance during bull markets: cash and more defensive stocks drag down the portfolio when the best market performers are high-beta stocks. However, I expect such a portfolio to deliver better results over the long term as the portfolio has the resources that can be deployed in a downturn.

Both S&P 500 and MSCI World (ACWI) outperformed HVG in the first nine months of 2024 (up 22.1% and 19.1%, respectively). However, since 2020, the HVG portfolio has outperformed MSCI World and delivered results in line with the S&P 500 despite having higher cash and making no significant allocation to the tech sector.

Given the high concentration of the S&P 500, with the top 10 companies accounting for 35%, and its high valuation (22x forward P/E, 1.3% dividend yield), the HVG portfolio appears to be much better positioned in the current environment.

Here is the composition of the Hidden Value Gems portfolio.

In Q3 2024, I started one new position, increased three other positions, and exited two positions.

Aercap is the world’s largest owner of commercial aircraft, which it leases to airlines earning lease payments.

I used to view Aercap as an asset-heavy business with economics similar to the financial industry (relatively low ROE, but more cyclical). I think this is still the consensus view and the reason why the stock is trading at just 10x P/E.

I have since changed my mind. The business provides critical service for airlines by making aircraft fleets available on a long-term and short-term basis. Airlines can focus on customer relationships and managing flights, including dealing with airports and regulators. Unlike other lease businesses, aircraft leasing is more stable as airlines maintain flights even if they sell 50% of the tickets.

In the current environment, the supply of aeroplanes and engines has dropped while demand has surged, which has put Aercap in a particularly strong position. It is the largest owner of commercial aircraft in the world and has one of the youngest fleets.

Consider the latest announcement from British Airways on cancelling hundreds of flights this winter due to a shortage of aeroplanes.

The company has been successfully selling its older aircraft in the secondary market for a 20% premium to book value while repurchasing shares at a 10% discount. With c. 75% of assets financed with debt, the sale price premium relative to discounted equity value rises to 90-100%.

Source: AerCap Investor Presentation 2024

Crucially, the same management team has been running AerCap for almost twenty years and has a great track record of consolidating major competitors, growing market share and delivering value to shareholders.

While the discount to book value has almost evaporated (Q2 2024 Book Value Per share was $89.5), I still consider the stock attractive given market tightness and Aercap’s leading positions in the industry.

At less than 10x P/E, 5-10% organic earnings growth and highly accretive asset transactions (selling older aircraft at premium valuations), the stock could easily offer 20%+ annual returns in the mid-term. I do not see reasons to sell the stock in the current environment.

CTT is one of the oldest European companies. It is a mail delivery business which was privatised in 2014. Two leading families took control of the business and have since transformed it into a leading delivery service in Iberia.

I met management in Madrid earlier this year and have since opened a position, which I increased in August after Q2 results.

The company targets €100-120mn EBIT in 2025. With a market cap of €598mn and €196mn net debt (excluding CTT bank), the company is valued at 7.2x EV/EBIT.

Importantly, the delivery business has high fixed costs (warehouse + wages to delivery personnel) and benefits from the rising scale. Not only does higher warehouse utilisation boost the company’s profits, but also more parcels delivered by a courier on a single trip reduces the cost of delivery per parcel (if a one-hour delivery trip costs €10, then delivering 10 parcels instead of just one on the same trip would push the cost per parcel from €10 to just €1).

*E&P stands for E-commerce and Parcels delivery
Source: CTT Investor Presentation 2024

This scale effect was evident in H1 2024 results, with Express & Parcels segment revenue rising 48.9% YoY (to €210.4mn), while segment operating profit increased by 132.8% (to €13.7mn). The margin has increased from 4.1% to 6.5% over the same period.

If you add the fact that Iberia has the lowest e-commerce penetration in Europe (c. 5% in Portugal and 15% in Spain compared to 27% in Germany and 40% in the UK), you can see that the business has a long runway ahead in terms of both sales and profits.

Source: CTT Investor Presentation 2024

The next important catalyst would be the finalisation of the deal with Generali, following the November 2022 agreement to sell an 8.7% interest in the CTT bank to Generali (for €25mn) as part of the partnership agreement to distribute Generali’s products in Portugal. I would not be surprised to see the bank being completely sold one day.

I plan to hold the stock as long as the company continues to expand its delivery business and return cash to shareholders (the latest €25mn share buyback programme launched on 19 July 2024 represents 4% of the company’s market cap).

I have held a 3% position in Corpay since December 2023. It is a niche payment processing company historically focused on fuel cards, having recently expanded in other verticals (lodging, accounts payable automation, parking and others). The business has historically delivered 10% organic revenue growth with an additional 5% growth from M&A for a total of 15% growth. It followed an aggressive share repurchase programme, which reduced the share count and boosted historical EPS by close to 20% growth.

Following lower fuel prices, a softer lodging market and exit from Russia, the company’s growth rates halved, raising the market’s concerns over its long-term growth potential. I viewed these issues as temporary and bought the shares.

Since then, the company has been gradually returning to its historical growth trajectory.

Its Q2 2024 revenue, reported in August, increased 7% (ex Russia), EBITDA was up +10% and adjusted EPS +14%. The company bought back almost 5% of its shares in H1 2024, which is in line with its historical commitments to shareholder returns.

On 1 July, Corpay acquired Paymerang, an accounts payable automation company, for $469mn, which is part of the company’s strategy to complement organic growth with selective acquisitions.

Corpay performed well in the past quarter on the back of brokers’ target price upgrades and JP Morgan's announcement that it accumulated a 7.4% stake in the company.

The stock is trading at 18x current year earnings and 15x on consensus 2025E estimates. This is below market multiples despite delivering 15% earnings growth. I continue to view the stock as attractive for now.