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Jan 27, 2023

4Q22 Opportunity Equity Quarterly Investment Review

Christina Siegel Malbon

Performance Attribution













Market Proxy is S&P 500. Returns greater than 1 year are annualized. Source: Bloomberg and Miller Value Partners
The data provided is from APX and Miller Value Partners, 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.

Strategy Highlights

During the fourth quarter of 2022, the Opportunity Equity strategy generated a total return of 1.85% net of fees excluding sales charges. In comparison, the Fund’s unmanaged benchmark, the S&P 500 Index, returned 7.56%.

Using a three-factor performance attribution model, selection, allocation, and interaction effects contributed to the portfolio’s underperformance. Taylor Morrison Home Corp., JPMorgan Chase & Co., Diamondback Energy Inc., Ovintiv Inc., and Teva Pharmaceuticals were the largest contributors to performance, while Silvergate Capital Corp., Inc., Farfetch Ltd., Coinbase Global Inc., and Alphabet Inc. were the largest detractors.

Relative to the index, the fund was overweight the Consumer Discretionary, Financials, Industrials, Communication Services, and Energy sectors on average during the quarter. With zero allocation to Real Estate, Utilities, and Consumer Staples the fund was underweight these sectors along with Information Technology, Materials, and Healthcare sectors.

The portfolio added three positions and eliminated four positions during the quarter, ending the quarter with 39 holdings where the top 10 represented 47.8% of total assets compared to 24.0% for the index, highlighting the fund’s meaningful active share of around 110.1%.

New and Eliminated

This quarter we entered three new names while exiting four names, as we looked to monetize names that had reached our estimate of intrinsic value. Our largest new position is Travel + Leisure (TNL), one of the world’s largest timeshare vacation operators with over 250 vacation resorts mostly under the Wyndham brand. The company was spun-out from Wyndham Hotels & Resorts in 2017 at a valuation more than double where it is trading today. The company, formerly known as Wyndham Destinations, has been on a journey to rebrand themselves purchasing Travel + Leisure in 2021, which has allowed them to upscale their brand, expand their business-to-business (B2B) opportunities and improve their marketing engine. The company was negatively impacted during the pandemic when revenue dropped -47% YoY; however, the company remained free cash flow (FCF) positive throughout the entire period due to its strong recurring revenue model that is underappreciated by the market. The company has guided to generating $2.5B in cumulative adjusted FCF from 2022-2025 (81% of its current market cap!), with the vast majority being allocated to buybacks and dividends (currently a 4.3% yield). Through the first 9-months of last year, the company repurchased $243M worth of stock (6.3% of shares outstanding) which we expect continued in the fourth quarter. The stock traded above $60 in early 2022 and ended the year at $36 based on recession fears.  We believe the business is more resilient than the market gives it credit and see potential for 50%+ upside on normalization alone. Trading at just 7.5x 2023 earnings vs peers in the same industry at 11.7x and hotels averaging 24.8x, we think Travel + Leisure is quite cheap.  With a total owner’s yield of greater than 10%, we believe the company can deliver quite attractive returns.

We also bought Chesapeake Energy Corporation (CHK), a majority natural gas play that trades at a discount to peers. The company emerged from Chapter 11 bankruptcy in 2021 with a substantially stronger balance sheet and lower cost structure. The company is a low-cost producer with a top land position.  It’s aggressively returned capital to shareholders - 19% of its current market cap in 2022! It pays a base dividend ($2.20, 2.5% yield), a variable dividend (50% of post base dividend free cash flow), complemented by a $2b buyback program (17% of shares outstanding), which is expected to be completed by YE23. With some less attractive hedges rolling off in 2023, the company is well positioned even in a lower natural gas price environment. We expect continued capital returns, supported by the company’s effort to sell their Eagle Ford oil asset, which is expected to catch roughly $3B. With the company continuing to trade at a discount to peers, while having the lowest cost of production and highest cash return yield, we think the risk/return is extremely attractive.

We re-entered Coinbase Global (COIN) during the quarter, after taking tax losses earlier in the year.  The company fell in sympathy with the broader cryptocurrency space, trading down to an all-time low of $32.53. Coinbase is the largest crypto exchange in the US, in addition to serving customers in over 100 countries. While Coinbase has limited direct exposure to the FTX bankruptcy, they are exposed to headwinds from industry shrinkage and fear. With the removal of a key competitor, Coinbase’s market share has grown.  We believe this incident will help build Coinbase’s reputation for innovation, trust and regulatory compliance. Trading volumes have fallen precipitously post-FTX impacting COIN’s revenue potential in the near-term. As a result, the company has announced aggressive actions to right-size the cost structure. With $5B in cash on hand, Coinbase is well positioned to weather this crypto winter. We continue to believe COIN has the potential to be the platform for crypto. Other platform models, like Apple, Facebook and Google, have generated some of the most attractive economics of any companies in history.  We do not believe you’re paying for that potential with the company trading at just 4x 2023 gross profit.

We exited Bausch Health Companies Inc. (BHC), Vontier Corp. (VNT), Bank of America (BAC) and Diamondback Energy Inc. (FANG) during the quarter.

Top Contributors and Top Detractors
Top Contributors Ticker Net Contribution (bps)
Taylor Morrison Home Corp TMHC 111
JPMorgan Chase & Co. JPM 82
Diamondback Energy Inc FANG 77
Ovintiv Inc OVV 64
Teva Pharmaceutical TEVA 61
Top Contributors Ticker Net Contribution (bps)
Silvergate Capital Corporation SI -242 Inc AMZN -136
Farfetch Ltd FTCH -93
Coinbase Global Inc Ordinary Shares COIN -76
Alphabet Inc GOOGL -35

*Contribution illustrated above are provided net of fees and includes cash.

Top Contributors

Taylor Morrison Home Corp. (TMHC) was the top contributor to the fund during the quarter. The company reported mixed third quarter results with EPS beating as the company remained disciplined on expenses but new orders were down -39% YoY. While the pace of demand has slowed, the company continues to allocate excess free cash flow to buybacks allowing the company to repurchase shares at a discount to tangible book. Going forward, we expect this trend to continue as the company slows their land acquisition spend with $320M outstanding on their buyback program (9% of shares). Despites consensus expecting EPS to drop ~42% in 2023, the company continues to trade at just 6x earnings. We think this is incredibly cheap for a smart management team that is remaining disciplined and returning cash to shareholders.

JPMorgan Chase & Co (JPM) climbed during the quarter after announcing better-than-expected 3Q results and boosting net interest income (NII) guidance. While there are still uncertainties, management thinks buybacks can restart in 1Q23, with the company still having $29.6B outstanding on their current buyback program (7% of shares). This would be on top of the current 3% dividend yield. With JPMorgan arguably the most dominant bank in the United States, they continue to prove out the benefit of scale, diversification and sound risk management. Despite concerns around a recession in 2023, CEO Jamie Dimon expects any recession to create opportunities for the company, much as it did during the financial crisis. The company continues to invest aggressively in new technology while aspiring to grow organically to 20% deposit market share in the US. With a top company and management team trading at just 11x next year’s earnings, we think the company will continue to compound capital over time at attractive returns.

Diamondback Energy Inc. (FANG) rebounded early in the quarter following oil prices higher. We took advantage of the strong move exiting our position. The company announced two acquisitions in the quarter, buying one company in the Midland Basin and one in the Permian as the company continues to expand its position in key areas. The capital return payout shifted up to +75% of FCF being returned to shareholders via a base plus variable dividend and repurchases, implying a 12% cash return yield. The company continues to remain disciplined in its M&A strategy and committed to its capital return policy.

Top Detractors

Silvergate Capital Corporation (SI) had a wild ride during the quarter with the final blow coming from the bankruptcy of FTX Trading Ltd in December. The company saw extreme levels of withdrawals as institutions began to pull back on their exposure to the space. The market priced in this risk well before the company announced actual results early in 2023. The company saw deposits fall from $11.9B at the end of September to $3.8b by the end of December, a 68% decline, and a level not seen since 2019. After reducing the workforce by 40%, and refocusing priorities, the company expects to be profitable moving forward. With the stock nearing our worst case scenario for tangible book value, we think this is an attractive opportunity. Inc. (AMZN) declined in the quarter after reporting third quarter results that missed on the bottom-line and providing disappointing 4Q guidance. While the company continues to focus on right-sizing the fixed cost structure, inflation continues to pressure the retail side of the business while AWS sales slow with increasing price concessions weighing on the topline. The company expected much of the same pressure to continue throughout the end of the year of 2022. As a result, headcount reduction and restructuring continued to grab headlines through the quarter and into the new year. Despite the near-term softening of the topline, we think the company remains well positioned for the long-term as the dominate player in the cloud, retail, and increasingly logistics and advertising space. We think Amazon is one of the best long-term risk-rewards in the market.  The company is significantly underearning its long-term potential with a proven team that is aggressively focused on improving profitability. It’s trading at only 10x consensus earnings for 2027 despite its dominant competitive position and growth potential.  Companies with those characteristics typically trade closer to 25-30x implying ample upside over the next few years.  We believe the current price doesn’t include any value for the core retail business, given the justified values for AWS and the ad businesses.

Farfetch (FTCH) fell in the quarter following the company’s capital markets day in December. The market reacted negatively to the 2025 EBITDA guidance of $350M which came in above consensus of $248M but clearly not above market expectations. We believe this guidance is overly conservative.  Management has built in ~$100M cushion to their guidance and assumes no new FPS (Farfetch Platform Services) deals, no growth in current FPS between now and 2025, and marketplace GMV growth of 9%, below online industry growth of 13%. Overall, we see multiple layers of conservatism built into numbers, with the company clearly looking to beat. As the company continues to make progress toward reaching FCF positive next year, we think this creates an attractive entry point into a long-term secular winner in the online luxury space.

Related Posts

Samantha McLemores's 4Q 2022 Opportunity Equity Commentary

Christina Siegel’s 4Q 2022 Market Highlights

The performance figures reflect the deduction of a model investment management fee of 1% (the highest fee for separate accounts under our fee schedule) and certain other expenses. For important information about Opportunity Equity Strategy performance, please click on the Opportunity Equity Strategy Composite Performance Disclosure . The performance returns shown in this report are preliminary and are subject to revision. Past performance is no guarantee of future results. This additional information applies to such performance for all time periods.

All holdings and portfolio data are reflective of the representative account for the Opportunity Equity Strategy.

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 Miller Value Partners 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 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.

©2023 Miller Value Partners, LLC