During the first quarter of 2024, the Patient Opportunity Equity representative account generated a total return of -1.9% net of fees. In comparison, the Strategy’s unmanaged benchmark, the S&P 500 Index, returned 4.3%.
Using a three-factor performance attribution model, allocation and interaction effects contributed to the portfolio’s underperformance which were partially offset by selection effects. Nvidia Corp. (NVDA), Alphabet Inc. (GOOGL), Amazon.com Inc. (AMZN), Biogen Inc. (BIIB), and Energy Transfer LP (ET) were the largest contributors to performance, while CVS Health Corp. (CVS), Coinbase Global Inc. (COIN), Mattel Inc. (MAT), IAC Inc. (IAC), and Expedia Group Inc. (EXPE) were the largest detractors.
Relative to the index, the strategy was overweight in the Consumer Discretionary, Communication Services, Financials, Energy, and Health Care sectors on average during the quarter. With zero allocation to Real Estate, Utilities, Materials, and Consumer Staples, the strategy was underweight in these sectors along with the Information Technology, and Industrials sectors.
The representative account portfolio added one position, Everi Holdings Inc. (EVRI), and eliminated two positions, Capital One Financial Corp. (COF) and Uber Technologies Inc. (UBER), during the quarter. The portfolio ended the quarter with 39 holdings where the top 10 stocks represented 49% of total assets compared to 34.2% for the index, highlighting the fund’s meaningful active share of around 90%.
Portfolio Review
The second quarter finished much like the first with the largest names continuing to lead the market. Nvidia Corp. (NVDA) accounted for an impressive 40% of the S&P 500’s return in the period followed by Apple Inc. (AAPL), Alphabet Inc. (GOOGL), and Microsoft Inc. (MSFT) accounting for 30%, 19%, and 10%, respectively. We benefited from our exposure to Alphabet Inc. (GOOGL), Meta Platforms Inc. (META), Amazon.com Inc. (AMZN), and Nvidia Corp. (NVDA). At the end of last quarter, we wrote about how select names within the Magnificent 7 were not yet pricing in euphoria. More of the names now look closer to fair value.
We see more attractive opportunities elsewhere and have increased our exposure to idiosyncratic opportunities in underfollowed and underappreciated ideas. We continue to see attractive upside in both traditional value names and small and mid-cap companies.
Our exposure to Health Care has increased throughout the year as a result of our bottoms-up fundamental analysis. We think the Health Care space is ripe with idiosyncratic opportunities that the market is not yet focused on.
Illumina Inc. (ILMN) is a good example. We entered the name late last year as the company began to trade at a 5-yr low. The company is a leader in the genomic sequencing space but made an ill-advised acquisition of Grail, a blood-based multi-cancer early detection product, in 2021 for $8B dollars. Grail was an annual ~$600m drag on profitability hitting the financials at the same time that competition began to pick up and the overall demand environment began to weaken. Despite increased competition in the genome sequencing space, Illumina continues to be a leader with ~80% market share today. With the successful separation of Grail Inc. (GRAL) in June, Illumina has now returned to a pure-play sequencing company. As the company returns to historical profitability post Grail spin-off and as the demand environment normalizes post COVID, we believe you can buy a market leader in a secularly growing industry for less than a market multiple.
Biogen Inc. (BIIB) is another name that we believe is underappreciated. As a global biopharmaceutical business, the company is most well known for their products in multiple sclerosis, spinal muscular atrophy, and most recently Alzheimer’s disease. The new CEO, Christopher Viehbacher, is working to improve the company’s pipeline, most recently with their acquisition of Human Immunology Biosciences Inc. in May. Chris has a strong track record of successful M&A and we expect him to continue that tradition. More importantly, we think the market is currently giving the company no credit for success in their Alzheimer’s indication. While the uptake in Leqembi, their Alzheimer’s product, has been slow, we still see strong long-term potential for a patient population that is dramatically underserved. We find the risk/reward extremely attractive.
While Royalty Pharma plc (RPRX) is in the health care space, it is more like an investment firm that buys royalty assets in the healthcare space. The company has an extremely strong track record, running the business for over 20 years as a private fund before bringing it public. The market opportunity for external royalty funding has only grown as early-stage start-ups need funding and legacy players are looking to lower their debt levels. We think Royalty Pharma is perfectly positioned as the partner of choice. The company is disciplined, maintaining deal internal rate of returns (IRRs) in the low-teens despite the higher interest rate environment. We think as the company continues to deliver as a public company, the market will start paying attention.
New and Eliminated
This quarter we entered one new position, while exiting two positions. We started a position in Everi Holdings Inc. (EVRI) during the quarter, a leading supplier of technology solutions for the casino gaming industry providing gaming machines, casino operational and management systems, as well as online gaming content. The company is in the middle of closing its acquisition of IGT’s Global Gaming and PlayDigital business in a cash and stock deal worth $3.8B at the time of the announcement. The stock sold off following the news, given the historical record of revenue dis-synergies in prior industry M&A deals. We believe this isn’t applicable here since neither company has meaningful product or market overlap. On a pro-forma basis, the combined company trades at just 4.2x 2025 EBITDA, an attractive valuationfor what will continue to be a market leader in the industry. We believe that as we move past the acquisition, the market will gain confidence in the long-term opportunity for the combined businesses and appreciate its strong cash generating dynamics.
We exited Capital One Financial Corp. (COF) and Uber Technologies Inc. (UBER) during the quarter to use as funding sources for our new ideas. Illumina Inc. (ILMN) spun-off Grail Inc. (GRAL) during the quarter leaving us with a very small position in the name. We exited our allocation of Grail during the quarter.
Top Contributors and Top Detractors
| Top Contributors | Ticker | Net Contribution (bps) |
| Nvidia Corp. | NVDA | 111 |
| Alphabet Inc. | GOOGL | 100 |
| Amazon.com Inc. | AMZN | 41 |
| Biogen Inc. | BIIB | 24 |
| Energy Transfer LP | ET | 23 |
| Top Detractors | Ticker | Net Contribution (bps) |
| Coinbase Global Inc. | COIN | -52 |
| CVS Health Corp | CVS | -51 |
| Mattel Inc. | MAT | -51 |
| IAC Inc. | IAC | -47 |
| Expedia Group Inc. | EXPE | -41 |
*Contribution illustrated above are provided net of fees and includes cash.
Top Contributors
Nvidia Corp. (NVDA) continued to lead both the market and the portfolio, remaining a top performer in the period gaining 36.7%. Nvidia is the market leader in designing and selling Graphics Processing Units (GPU), which has recently benefited from the insatiable demand of artificial intelligence (AI) models. The company currently captures 92% market share of data center GPUs and grew revenue, earnings and free cash flow (“FCF”) an astounding 126%, 392%, and 610%, respectively, over the last year. While we expect competition to increase, we think NVDA can continue to maintain top market share. While many are concerned with backlog times shortening, we think the rollout of the B100, which promises 2.5x better performance for only 25% more cost, later this year will create more shortages. With leading edge technology, an increasing innovation cycle and strong cash generation, the company is well positioned for the increased adoption of artificial intelligence (AI).
Alphabet Inc. (GOOGL) was a top contributor in the second quarter, finally catching up to its peers in the Magnificent 7. The company gained 20.8% in the period following strong first quarter earnings, a new $70B repurchase program (3% of shares outstanding) and the initiation of a cash dividend ($0.20 per share; 0.42% yield). We continue to believe the market underappreciates Google’s exposure to AI with its Gemini model being integrated into search results, YouTube advertising and its cloud offering. We continue to think that the cloud players will be the AI winners in the long-term, with Google being well positioned to take advantage. While the company trades at 24x 2024 earnings, if you remove the money-losing and under-earning businesses, you realize that you are paying below a market multiple for the core Google business. We do not believe there are many other AI winners trading at such an attractive multiple.
Amazon.com Inc. (AMZN) moved higher throughout the second quarter as AI demand helped to reaccelerate growth in their AWS business. It looks as though the cloud business is finally past the customer cost optimization period with customers restarting their cloud migrations as well as expanding spend on AI projects. Despite the top and bottom-line improvement seen in the first quarter, the company is significantly underearning its long-term potential as it continues to reinvest aggressively in the business. With 80% of global retail sales still being done in physical stores and 85% of global IT spending still on-premises, we see a long-run way for the dominant player in the cloud, retail, and increasingly logistics and advertising space.
Top Detractors
CVS Health Corporation (CVS) declined in the period following a disappointing first quarter earnings announcement and cut to guidance. The company reduced full year EPS guidance by ~16%, almost entirely driven by higher-than-expected costs in Medicare Advantage. Skepticism remains on management’s ability to execute and move past these issues but given the magnitude of the stock reaction (~19% decline) we think the risks are more than priced in at these levels. The issues with Medicare Advantage are now known and the company is working to fix them. With time, we believe they will be corrected. We continue to think CVS has an attractive long-term opportunity with its unique combination of assets owning a healthcare benefits business (Aetna), a pharmacy-benefits manager (Caremark), an in-home evaluation business (Signify Health) and in-home primary care business (Oak Street Health) supporting the industry transition to a value-based care model. While the most recent missteps are disappointing, the company still only trades at 8x lowered earnings estimates while continuing to pay a dividend (5% yield) and execute its repurchase program (16% of shares outstanding).
Coinbase Global (COIN) was a top detractor following cryptocurrencies lower throughout the quarter. While cryptocurrencies are going through a digestion period following the all-time high reached by Bitcoin in March, we believe it is still the early innings for institutional adoption and exposure to cryptocurrencies. We believe Coinbase continues to solidify its position as the platform of choice for the crypto-ecosystem and will benefit from this increasing demand over time.
Mattel Inc. (MAT) fell in the second quarter on a weaker top line despite margins coming in ahead of expectations. While many are concerned around lapping the hit Barbie movie this year, we believe the Barbie movie is just the beginning of Mattel’s multi-year journey to transition to an IP-driven, high-performing toy company. Regardless of near-term topline results, margins should continue to expand as the company has made efforts to improve efficiencies and removed fixed costs. Longer-term, as the company executes its IP driven transition, returns on invested capital and free cash flow generation should improve, allowing the P/E multiple to expand. In the meantime, the company continues to return cash to shareholders with a repurchase program representing 16% of shares outstanding.
Market Proxy is S&P 500. Returns greater than 1 year are annualized. Source: Bloomberg and Patient Capital Management
The data provided is from APX and Patient Capital Management, LLC 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.
• Allocation. 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.
• Selection. 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.
• Interaction. 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.
Returns illustrated above are provided net of fees and include cash. Total portfolio return figures provided above reflect the sum of the returns of the holdings in the representative account portfolio due to price movements and dividend payments or other sources of income.
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The S&P 500 Index is a market capitalization-weighted index of 500 widely held common stocks. Investors cannot invest directly in an index and unmanaged index returns do not reflect any fees, expenses or sales charges. Magnificent 7 is a group of stocks made up of mega-cap stocks Apple (AAPL), Alphabet (GOOGL), Microsoft (MSFT), Amazon.com (AMZN), Meta Platforms (META), Tesla (TSLA) and Nvidia (NVDA). Earnings per share (EPS) is a company’s net income subtracted by preferred dividends and then divided by the average number of common shares outstanding. Free cash flow (FCF) is the cash a company generates after taking into consideration cash outflows that support its operations and maintain its capital assets. Price to Earnings (PE) ratio measures a company's current share price relative to its per-share earnings. Internal Rate of Return (IRR) is a metric used in financial analysis to estimate the profitability of potential investments.
Earnings growth is not representative of the Fund’s future performance.
This information does not constitute, and should not be construed as, investment advice or recommendations with respect to the securities and sectors listed. All investments are subject to risk, including the possible loss of principal. There is no guarantee investment objectives will be met. Neither Patient Capital Management, LLC, nor its information providers are responsible for any damages or losses arising from any use of this information.
The Opportunity Equity composite performance figures reflected above include the deduction of a model investment management fee of 1% (the highest fee for separate accounts under our fee schedule), paid quarterly and certain other expenses. For important information about Opportunity Equity Strategy performance, please click on the Opportunity Equity Strategy Composite Performance Disclosure. Past performance is no guarantee of future results.
All holdings and portfolio data are reflective of a representative Opportunity Equity account.
Performance in attribution table is not official strategy returns. The return is sourced from APX and is net of fees based on the strategy’s representative account.
Contributors detailed above represent the top five securities that contributed positively to performance during the quarter. Detractors detailed above represent the top five securities that detracted from performance during the quarter. Information detailed above is provided net of fees, includes cash, and is based on a representative Opportunity Equity account. Contribution listed above represents the period when the security was held during the quarter. For additional information on how Top Contributors and Top Detractors were determined and/or to obtain a list showing every holding’s contribution to the representative Opportunity Equity account performance contact us.
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. References to specific securities are for illustrative purposes only. Portfolio composition is shown as of a point in time and is subject to change without notice.
The views expressed in this commentary reflect those of Patient Capital Management analyst(s) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Patient Capital Management 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.
Click for the Opportunity Equity Strategy Composite Performance Disclosure.
©2024 Patient Capital Management, LLC
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