Using a three-factor performance attribution model, selection and allocation contributed to the portfolio’s underperformance which was marginally offset by the interaction effect. iShares 20+ Year Treasury Bond ETF Put Options 1/20/23 P140, Alibaba Group Holdings Ltd., Karuna Therapeutics and Uber Technologies Inc. Call Options 5/19/23 C37.5 were the largest contributors to performance, while Norwegian Cruise Line Holdings Ltd., Bausch Health Companies Inc, Cleveland-Cliffs Inc, Coinbase Global Inc, and Amazon.com Inc were the largest detractors.
Relative to the index, the fund was overweight the Consumer Discretionary, Financials, and Energy sectors on average during the quarter. With zero allocation to Real Estate and Utilities the fund was underweight these sectors along with Communication Services, Consumer Staples, Industrials, Information Technology, Materials, and Healthcare sectors.
The portfolio added two positions and eliminated seven positions during the quarter, ending the quarter with 40 holdings where the top 10 represented 45.8% of total assets compared to 27.0% for the index, highlighting the fund’s meaningful active share of around 91.3%.
New and Eliminated
The strategy looked to take tax losses and capitalize on dislocations between fundamentals and expectations, particularly in the travel sector, over the quarter. Our largest new position is Expedia Group Inc. (EXPE), a leader in the online travel space. Despite a significant rebound in travel and Expedia’s EBITDA projected to reach record levels, Expedia is down 46.6% YTD versus the S&P500 down 17.6%. The company continues to see strong demand with overall traffic to Expedia brand websites growing 59% YoY and 36% YoY in April and May. The company has been on a multi-year transition focusing on launching its single tech platform to host all its brands and products which is expected to launch in 2023. This will help create efficiencies within the business which has long-run each brand as a stand-alone operation. From a cost perspective, the company has been focused on exiting less profitable markets (namely Southern Europe) while also pulling back marketing spend that historically would compete with owned brands. The company is on track to realize ~$1B in savings. While the market is focused on recession, historically, overall travel spending during recessions (outside of COVID) result in spending declines in the high-single digits. With the stock trading down 4x as much, this seems more than priced in. The high free cash flow generation provides further support to the stock with the company expected to average a 20% free cash flow yield in 2023. We believe this company presents an attractive risk/reward benefitting from an internal transition, externally strong pent-up demand, and strong FCF generation.
United Airlines Holdings (UAL) was the other new addition in the quarter. The airline sector struggled in the second quarter as the market focused on rising input costs, particularly fuel. Despite this, CEO, Scott Kirby, called out a once-in-a-decade opportunity citing stronger demand than he has ever seen in his career and that’s even before business and international travel has fully recovered. The consolidation of US legacy players led to a decade-plus of more capacity discipline which is now being further enforced by the pilot shortage which is expected to last through the decade. This natural limit on capacity growth should support better pricing power with further benefits from high operating leverage in the business model. United is uniquely positioned as the company has the ability to grow earnings power through up gauging its fleet (adding more seats) without the need for additional pilots. As the company has focused on the customer over the last few years, we have seen strong improvement in NPS (net promoter score) scores which should continue to flow through the model via better TRASM (total revenue per available seat mile) and higher cash flows and earnings. The company has guided for $20 in EPS in 2026, or a 1.8x multiple, which no one appears to be giving them credit for. For a company that is positioned to benefit from strong pent-up demand, guiding for record 2Q revenues with positive free cash flow, and liquidity levels more than double historical levels, we think the market is undervaluing this once in a decade opportunity.
We exited the Herbalife Nutrition Ltd (HLF), Tupperware Brands Corp (TUP), and WW International Inc. (WW) in the quarter to take advantage of tax loss harvesting. The JD.COM Call Options C75 1/24 and the Uber Technologies Inc. Call Options C37.5 5/23 were exited to lower the leverage within the strategy while being used to increase stock weightings. Stitch Fix Inc. (SFIX) was a small position that was used to fund new ideas while Tivity Health Inc. (TVTY) was exited following its announced acquisition by Stone Point Capital in April.
Top Contributors and Top Detractors
| Top Contributors | Ticker | Contribution (bps) |
| TLT 2023 Put Options | TLT US 1/23 P140 | 179 |
| Alibaba Group Holding Ltd. | BABA | 36 |
| Karuna Therapeutics Inc. | KRTX | 3 |
| Uber 2023 Call Options | UBER US 1/23 C37.5 | 2 |
| Top Detractors | Ticker | Contribution (bps) |
| Norwegian Cruise Line Holdings Ltd. | NCLH | -202 |
| Bausch Health Companies Inc. | BHC | -167 |
| Cleveland-Cliffs Inc. | CLF | -166 |
| Coinbase Global Inc. | COIN | -164 |
| Amazon.com Inc | AMZN | -156 |
Top Contributors
Our puts on the 20+ year Treasury Bond ETF (TLT US 1/20/23 P140) which we initiated as a hedge in 2021 on expectations that interest rates would rise, contributed the most to quarterly performance. The position benefited as the long-end of the curve continued to move higher as the Federal Reserve raised the short-end of the curve through increasing rate hikes. The 30-year reached a level not seen since 2018, ending the quarter at 3.18%. We’ve trimmed the position, but have maintained a continued hedge.
Alibaba Group Holdings Ltd. ADS (BABA) was a top contributor to the fund in 2Q as the company fought its way back from the lows seen in 1Q as the Chinese market began to re-emerge from strict lockdowns in April. The company reported 4Q results which beat low expectations while returning cash to shareholders via increasing buybacks. While major uncertainties continue to surround the Chinese market regarding the strict adherence of their Zero-COVID policy, and whether or not tech regulation has peaked, Alibaba largely appears to be pricing in significant pessimism. With the stock trading back to 2016 price levels, despite expected earnings 4x larger, we believe you are getting a top player in the Chinese market, with a defensible cloud position at an extremely attractive valuation.
Karuna Therapeutics Inc (KRTX) had a lot of volatility over the quarter but ended up largely flat. We’ve done well with the position since initiation. The company is still clinical stage but has a largely de-risked asset, KarXT, focused on schizophrenia, a treatment area that has not had a new innovative treatment in decades. The company has shown strong Phase II data with Phase III results expected within weeks and an NDA (new drug application) submission expected in 2023. Furthermore, the company is developing KarXT in Alzheimer’s disease psychosis, providing the potential for further upside, a patient population where the mechanism of action has historically demonstrated both cognitive and behavioral improvements. We think the large opportunity in the schizophrenia space alone justifies a price more than double where it is currently trading.
Top Detractors
Norwegian Cruise Lines Ltd (NCLH) declined over the period returning to price levels not seen since the lows in 2020, just as fundamentals started looking up despite the company expecting record adjusted EBITDA in 2023. The company is expected to resume generating positive operating cash flow in the second half of this year. Despite the strong outlook, the company is currently trading at almost half its long-term average P/E of 12x, implying a double from here simply on a return to historical averages. With strong pent-up demand and bookings that continue to track strongly, we think you are getting an opportunity to buy a name at COVID fire sale prices right with strong and improving fundamentals.
Bausch Health Companies Inc (BHC) declined during the quarter as the company consummated its Bausch+Lomb IPO at valuations far below expectations, reported disappointing Q1 2022 results and delayed its plan to spin out its Solta (aesthetics) business due to difficult market conditions. While the company spun-off 10% of Bausch+Lomb (BCLO) they retained 90% of the company which they intend to distribute once they have met their target leverage ratio of 6.5-6.7x. The future spin-off value of the Bausch+Lomb piece represents a value of $12.55 per share, 39% above where Bausch Health is currently trading implying that you are getting the core business and Solta for free. The company recently appointed John Paulsen as Chair of the Board, which should accelerate value realization.
Cleveland-Cliffs Inc (CLF) followed steel prices lower over the quarter despite posting strong 1Q results and increasing full year average selling price (ASP) guidance as recession fears grew. We think the market is underestimating the stability of earnings with 40% of contracts being long-term fixed rate. Cliffs has been on a multi-year transition to become the largest North American vertically integrated steel manufacturer holding 35% market share in the USA. Given the likelihood of rising scrap prices as more supply shifts to electric arc furnaces, CLF’s vertically integrated model should provide them a relative advantage. While steel prices could continue to fall in the near-term, we believe the company is worth $40 at our long term expected steel price deck. As the company continues to generate strong free cash flow, they are focused on returning that cash to shareholders with an outstanding repurchase program representing 12.4% of shares outstanding, which should provide support for the stock.
Performance Attribution
The data provided is from FactSet Research Systems and is believed to be reliable, but is not guaranteed as to its timeliness or accuracy. Percentages and returns may not sum to 100% due to rounding effects. A three-factor attribution consists of the allocation effect, selection effect, and the interaction effect, which sum to the portfolio's performance relative to the benchmark. Parentheses indicate a negative number.
*Returns based on underlying portfolio equity long holdings for each sector.
• The allocation effect represents the portion of the portfolio's excess return attributable to differences in sector weights between the portfolio and the benchmark index.
• The selection effect represents the portion of the portfolio's excess return attributable to differences in the weights of individual securities within each sector between the portfolio and the benchmark index.
• Most complex and sometimes counterintuitive, the interaction effect represents the portion of the portfolio’s excess return attributable to combining sector allocation decisions with security selection decisions and is often thought of as measuring the accuracy of manager’s convictions.
Please note that the methodology used by our independent third-party attribution software vendor will at times present sector allocation effects that are counterintuitive. For example, the software may calculate a negative sector effect even when the portfolio, on a weighted average basis for the period, was overweight an outperforming sector. Under the vendor's methodology, allocation effects in recent months may overwhelm the allocation effects from earlier in the period, particularly over longer time frames.
Related Posts
Samantha McLemores's 2Q 2022 Opportunity Equity Commentary
Christina Siegel’s 2Q 2022 Market Highlights
For important additional information on Opportunity Equity strategy performance, please click on the Opportunity Equity GIPS Composite Disclosure. This additional information applies to such performance for all time periods.
Contact Miller Value Partners to obtain information on how Top Contributors and Top Detractors were determined and/or to obtain a list showing every holding’s contribution to Strategy performance.
Contributors detailed above represent the four securities that contributed positively to performance during the quarter. Detractors detailed above represent the top 5 securities that detracted from performance during the quarter. Information provided above is based on a representative Opportunity Equity account.
The views expressed in this report reflect those of the Miller Value Partners strategy’s portfolio manager(s) as of the date published. Any views are subject to change at any time based on market or other conditions, and Miller Value Partners disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results.
©2022 Miller Value Partners, LLC
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