Pro Weekly Digest: Upslope Capital Management On Quick-Promoting And High quality Longs – Owens-Illinois, Inc. (NYSE:OI)

Welcome to the most recent issue of the Pro Weekly Digest. Each Saturday for Searching for Alpha Pro subscribers and Sunday for all different In search of Alpha customers, we publish highlights from our Pro coverage as well as function interviews and other notable goings-on with SA Professional. Comment below or e-mail us at professional-editors at seekingalpha.com to let us know what you suppose. Find past editions here.

Feature interview

Salvatore Ferragamo Tweed Midi Dress - Clothing - SAL43102 ...It seems apparent to say this in 2017, but the internet makes it simpler to make one’s name. Or no less than, it increases the quantity of ways someone can gain consideration in any given subject. It additionally increases the number of people attempting to achieve attention, without giving the viewers more time to actually consider more folks, so there’s a zero-sum game. But there’s a flattening impact that not less than will be more meritocratic.

Seeking Alpha is built on this principle, but there are other locations the place this occurs. Twitter (TWTR) affords up loads of noise, however there are also focused communities where anyone can acquire a following so long as they add value. “Fintwit”, or the monetary nook of Twitter is one of those locations.

George Livadas is the portfolio supervisor of Upslope Capital Management, an alternative funding management firm, and a brand new Searching for Alpha Contributor. He launched this 12 months after experience on each the buyside and the sellside, including managing a portfolio at SCB International Capital. Relevant to our lead, he launched with some fanfare as a consequence of the next he had constructed on twitter under the account NoonSixCap, becoming an integral a part of the fintwit group.

SA’s Daniel Shvartsman emailed with George about the present local weather for energetic administration, how he uses fintwit in his process, and his method to brief selling. George additionally shared a declining business he is shorting and a turnaround luxury model play he owns in his portfolio.

Looking for Alpha: Business stories predominantly focus on the rise of AI, indexing, algorithmic trading, and sub-par returns for hedge funds either simply because we’re in a bull market or by means of the cycle. It’s fairly the “tape” to be going against, and there are tons of talented managers out there preventing it. How did you weigh these items out as you decided to launch Upslope?

Upslope Capital Management: A number of issues: first, this is something I’ve really wanted to do for about a decade. Now I’m 35, have a young family, and examine it as a now-or-never factor, given my non-traditional profession path. So, there’s numerous self-imposed bias right here and a will to make it work.

Second, you never know if it’s actually “different this time, but I have read some compelling research on energetic administration cycles that means we might be near a bottom for active management. Particularly, a recent piece from Goldman Sachs famous some key themes. First, “alpha is cyclical. GS recognized four distinct “alpha cycles since 1990 (we’re presently in the longest down-cycle). Second, energetic managers perform better in “value (vs. growth) market regimes (we’ve been in a development regime for 9+ years – the longest on report). And eventually, active managers underperform in markets with only a few pullbacks. So, I’m optimistic on the cyclical front.

Of course, there are nonetheless secular headwinds. On that entrance, I’ve tried to construct a differentiated product with a pretty technique and structure that I hope will thrive, despite the headwinds. What does that mean? Lengthy/short, midcap-focus, excessive lively share (I consider it responsibly concentrated: ~10 longs, 10 shorts, seventy five-125% gross), larger transparency and liquidity (advantages of an SMA-only vs. pooled car structure), and, in fact, a extra cheap, performance-oriented (the place attainable, given regulations) charge construction.

Ultimate factor to note: it’s not misplaced on me that the most beneficial funding observe information span at the very least a full market cycle. Given the age of this bull market, I wished to get moving and have the chance to invest and protect capital through a bear market in the following 1-2-3 (?) years. Whereas I was getting my MBA (2008-10), I spent manner a lot time actively investing in and trading stocks. It was most likely on the expense of my grades and job search; but, I genuinely enjoyed the challenge and look forward to the subsequent alternative.

SA: You’ve got built up a sizable following on twitter. I do not wish to overstate it, however how does twitter match into your strategy? Is it simply an outlet to let off steam or for leisure, a sounding board, or something else?

UCM: After i first joined “finance twitter in mid-2015, it was simply an outlet to talk stocks. I had simply left the promote-side, the place taking investor calls and being in the data circulation is an enormous a part of the job. I missed that immediately. It quickly turned obvious that a healthy contingent of the “fintwit group had been real skilled traders (confirmed after meeting 30+ in-person over time) and/or just very good folks.

As we speak, I exploit it for all the reasons you mentioned. It’s a improbable sounding board for potential funding concepts. Over time, you get to know certain individuals, their kinds, and the way in which they assume. The feedback can be very beneficial. And then I’ll confess, with zero shame, that it can be a very good source for ideas (obvious disclaimer: shopping for someone else’s ideas without doing your individual work is a recipe for failure – even when it’s a good idea!). Lastly, sure, I also use it for entertainment functions – to gossip about the markets and try to convince extra folks to go away NYC and be part of me in Colorado.

SA: I wished to ask about a pair concepts that appeared to run their course on fintwit over, say, 2015-16. First, there was the theme that high quality > value; in other words, purchase good companies and cease worrying in regards to the multiples. It was a Buffett 1.Zero (cigar butts, pre-Munger) vs. Buffett 2.0 (great corporations at a good worth, publish-Munger) discussion. It appears that’s died down somewhat lately as some ‘high quality’ names gave up quality or bought expensive. What are your thoughts on quality vs. worth?

UCM: This is a matter I’ve developed on. I’m within the “quality at a fair price camp. After i originally started Upslope’s strategy (beneath a prior agency), I decided to focus the core of the portfolio on high-high quality businesses, however deliberately allocate some capital to extra modest and even low high quality/distressed companies. My assumption was that the market may have cycles favoring every high quality tier over time, and that being versatile and opportunistic to find value is the best approach.

Nonetheless, I found that I’m a poor manager of low-high quality positions. I’ve the stomach for giant draw-downs in businesses I’m assured are high- or even medium-quality. However, for low-high quality companies with more restricted competitive advantages and/or challenged monetary models, I can’t sit tight. I want that weren’t the case, however that’s the truth. So, I’ve reduce that very bottom (low quality) tier out of my technique. It was also a sensible decision, since, from a risk administration perspective I was sizing these low-quality names much smaller. They’d eat up numerous time and mental power – and for what?

SA: The opposite idea that had buzz however has pale is the obsession with one’s edge. There was a interval where every investment resolution had to be justified by an edge distinctive to a given investor or agency, however now one’s extra likely to see #edge as a punchline. This is fascinating too as a result of as soon as something reaches a public discussion board like Twitter or In search of Alpha, most informational edge is gone. Given all that, how do you get comfortable enough with a position to think you do know or perceive something the market doesn’t for a given firm?

UCM: This could be sacrilege, but I feel many skilled buyers focus far too much on identifying a specific edge or “variant notion” before putting on a place. For those who perceive that the fundamentals of the business (vs. valuation multiple) are the primary driver of returns over time, you’ll be able to see why just determining whether or not a business will do effectively (or poorly) over the lengthy-run should be the first focus. Obviously, that’s extraordinarily difficult. But, I don’t spend time compiling clever bullet factors on my ‘variant notion. I get a general feel for what the consensus view is (qualitative analysis) and what expectations are embedded in the current worth (modeling). Then I weigh that vs. my very own opinions. In summary: not-obsessing-over-edge = #edge.

SA: Last twitter derived query. You’ve had an attention-grabbing collection of sentiment indicators, and also you known as out Jeremy Grantham’s ‘this time is different’ argument in your last quarterly letter. You cite ‘continued unease with broader markets’ at the tip of the letter. The place do you think we might be headed, or if you’d reasonably avoid a macro query, how are you positioning your self provided that unease?

UCM: I’ve two hobbies: taking part in hockey and calling the direction of the market. I’m much better at the previous. Whereas I enjoy chatting about where the market may be headed – and i definitely have opinions – I don’t lean on these views a lot for actual investing. I’m targeted on picking stocks. I’ve some portfolio guideposts for internet lengthy and gross publicity (25-75% and 75-125%, respectively). Apart from that, I attempt to let the presence (or lack thereof) of high-conviction funding ideas guide the place I fall inside those ranges.

To attempt to reply the question although: the market seems costly to me. There are compelling arguments for why it may very well be different this time (low charges, larger margins, better returns). Those arguments apart, for those who reduce out 90’s tech bubble period valuations, it gets pretty laborious to get excited at present. I’m finding it harder to find good long ideas. I think Upslope’s portfolio is conservatively positioned, with modest net lengthy publicity (<45%) and a sizable portion of our long book in more defensive names. I can sleep at night.

SA: You talked about brief selling fairly a bit in your Q2 letter. What’s your process for locating shorts, generally?

UCM: Not a lot completely different than my process for locating longs. I’ve three sources for concepts: (1) firms I’ve coated in-depth up to now (packaging, exchanges/brokers, and other corporations I’ve owned), (2) recent transactions (IPOs, spin-offs, M&A, and many others.), and (3) the catch-all “walking around method (research firms that seem fascinating and see where it leads me). I’m suspicious of screens and assume they can lead to poor outcomes. Certainly, I look for different qualities in shorts. A number of particularly: persistently low returns on capital, capital hogs (fixed need to boost capital), secular headwinds (lack of core sales development), promotional and/or usually lousy administration.

SA: It looks like on shorts being in a crowded commerce is riskier than on the long facet; do you agree with that, and if that’s the case, how do you keep away from getting stuck in a crowded trade?

UCM: Sure, I fully agree. Like many, I’ve a preference for shorts that aren’t crowded. Most of my shorts have fairly modest short curiosity. However, the place the thesis is compelling sufficient, I’m comfortable shorting what I refer to as “battleground shorts (e.g. Tesla (TSLA)- no position).

The #1 rule for crowded shorts: do not blow yourself up. Should you suppose that is hyperbole, I encourage you to analysis the Porsche/Volkswagen saga from 2008. I tackle the problem at the beginning by place sizing and, second, by means of more active place management. I used to suppose it was a waste of time to have a 1% (or smaller) position. But, I’ve come to appreciate that a 1% brief that works effectively can transfer the needle. This means pressing shorts as a situation develops favorably, and realizing when to take beneficial properties. I’m additionally generally fast (or try to be) to cut losses when battleground shorts go towards me. There isn’t a shame in taking a small loss and waiting patiently for a better alternative.

SA: What’s a current quick concept, and what’s the story?

UCM: We are short Owens-Illinois (OI). OI is a leading producer of glass packaging products worldwide. Suppose Bud Gentle and Pepsi bottles. It’s a slowly dying business, for my part, as glass is shedding share to cans globally. Barring a major fall within the dollar, I don’t see how longer-time period consensus sales estimates will be achieved. The money circulate profile also seems better than it really should, in my opinion. Over the last five years, administration (present and prior) has extracted around a half of a billion dollars of working capital from the business and lower the cash conversion cycle by virtually two-thirds. That is nice for shareholders, but clearly has been a material contributor to money flows. I wonder how far more they will pull out.

The other non-working stabilizer of FCF is the declining annual asbestos settlement payments. This has truly been a point in the bull thesis for some time (the view being that funds will eventually go to zero and supply a tailwind to free money stream). The declining funds are providing a tailwind to FCF growth. But, my view is that after they go to zero, shareholders will probably be left with flat-to-declining cash flows.

Finally, I don’t consider OI has a lot room for error. The inventory doesn’t seem notably cheap: even for those who assume consensus estimates are cheap, OI trades at an eight 8.5% 2018 FCF yield. Operationally and financially, that is a troublesome business. Whereas OI has had a good run below new administration, there have been long stretches within the company’s historical past where operational points popped up like a whack-a-mole sport (to steal a phrase from my previous boss at BMO). Combine all of the above with OI’s full stability sheet (4x internet leverage), and i like the risk/reward on the brief aspect.

SA: You did not mention a selected catalyst here or as part of your shorting method. What’s the timeframe the place you suppose the lacking estimates/obsolescence story performs out?

UCM: I feel 2018 free money circulation guidance (should come out round year-end outcomes) will disappoint. Proper now, consensus FCF estimates look about 20-30% too excessive for 2018 and 2019, in my opinion. Trying again at historic data (specifically, FCF margins since 1995), there seems to be an assumed step-change in core free cash movement (excluding asbestos and working cap). Based on my normalized estimate for 2018 FCF, the stock is trading ~7.5% FCF yield. Given the lack of natural high-line development, low probability of serious further growth in margins from right here (in my opinion), and other points beforehand talked about, that appears awfully tight.

SA: Briefly, you mention a falling dollar as sort of an escape hatch for OI to satisfy estimates. The long concept you mention under additionally has foreign money exposure, and your current letter confirmed 27% gross exposure to non North American firms. How a lot do you consider forex danger in your portfolio administration and/or inventory selection, and how do you mitigate it?

UCM: Good query. Given my technique (domestic-targeted, but with a cloth allocation to worldwide, developed market companies), I’m extremely conscientious of holdings with FX threat, however don’t feel a necessity for a formal policy to handle it. As a substitute, I manage FX threat on a case-by-case foundation. I’ll give two examples.

First, my greatest concern tends to be situations the place FX can have a cloth impact on margins (i.e. price / revenue mis-match). Ferragamo poses the most important risk on that entrance. So, I don’t really feel the necessity to do something on the FX entrance right here.

Second, my next greatest concern is pure translation risk. These are corporations with outsized non-USD publicity, but a good matching of revenues and bills by forex. Certainly one of our largest longs is Crown Holdings (CCK), a meals and beverage can business that generates about two-thirds of gross sales outdoors the US. Given the dimensions of the place and the potential impression an adversarial move in the dollar may have, I did really feel compelled to handle FX risk right here. It’s not good, but I’ve done that by…shorting Owens Illinois. OI has a roughly comparable FX profile; and, if something OI is marginally extra levered to a weak US greenback.

SA: On the long side, you write that “We aren’t wedded to “low-a number of” stocks and usually seek companies with the very best stage of lengthy-term durability for the bottom price.” What are key indicators of long-term sturdiness for you, and what kind of holding interval do you often count on when investing?

UCM: I want qualitative signs of aggressive advantage which are straightforward to explain and logical (e.g. don’t do backflips to pretend each other enterprise has network effects). These may very well be obvious community results (like an trade), scale advantages, proprietary expertise, or any of the opposite classics. I also look for quantitative indicators: attractive returns on capital and incremental capital, economic value-add, consistent core sales growth.

Though it doesn’t at all times work out this way, I generally underwrite new positions assuming a 2+ yr holding period for core longs, 1+ years for more tactical longs, and 3-18 months for shorts.

SA: What’s a present long thought, and what’s the story?

UCM: We recently added Salvatore Ferragamo Italia (“SFER:IM”) (OTCPK:SFRGY) to the portfolio. As I’m sure many are conscious, Ferragamo is a designer and producer of luxurious footwear, leather items, apparel, and accessories. About forty% of gross sales come from footwear, 40% from leather-based goods (e.g. handbags, wallets), with the remainder split amongst apparel, equipment and fragrances. SFER may be very world: >50% of its retailer base is in APAC and, based on my estimates, >50% of gross sales come from emerging market consumers (emerging market-based mostly stores plus significant tourist sales in developed market shops, e.g. Chinese tourists visiting Paris).

Why do I like it? First, I imagine the Ferragamo brand has real value (traditionally strong returns on capital and development) but has change into temporarily out of favor. Second, this can be a household-owned enterprise (I view that as a positive on this case, given the legacy and seemingly-centered Chairman, Ferruci Ferragamo) with contemporary, independent leadership that seems qualified to engineer a profitable flip-around. Third, though not optically “cheap, I consider expectations for SFER are low. 2017 has been written off as a transition year (most likely rightly so). The stock has considerably underperformed over the last year and trades at cheap multiples on very achievable lengthy-time period estimates. Lastly, given Gucci’s (parent company: Kering (OTCPK:PPRUY)) current, extremely successful turnaround, it’s not laborious to envision Ferragamo gaining traction in the approaching year and buyers quickly viewing SFER as a “Gucci Turnaround 2.0 story.

SA: At a superficial level, it looks like brands are under stress as younger shoppers’ agnostic preferences and the ability to buy in every single place from anywhere erode traditional moats. Do you worry about that at all, and if that’s the case, how does SFER succeed within the face of that?

UCM: First off: after i started taking a look at Ferragamo, it was as a result of I was looking for a contrarian play for the retail Armageddon we’re going by. So, these are definitely very real dangers for the inventory. But, I’m snug with Ferragamo for a number of key causes. First, luxury appears extra insulated than down-stream manufacturers. The obstacles to entry are greater (high quality, design fireplace-energy, marketing spend, “Made in Italy image for SFER, and many others.) and that i believe folks around the world will all the time be taken with luxury items and brands as incomes expand. Second, probably the most at-risk category from the issues you noted appears to be apparel. SFER has comparatively minor publicity (7% of 2016 sales) right here. So, while I remain very involved about the general setting, I’m comfortable with the horse we’ve guess on.

SA: What about the recent management offers you confidence that SFER’s management is going in the proper route?

UCM: I’ll confess it’s not easy for me to confidently “underwrite the company’s new trend leadership and their past works. However, the research I’ve performed (talking with business sources, reading trade rags) leaves me optimistic – notably close to Paul Andrew, the inventive director for women’s collections. It was controversial when SFER initially named three new heads of design (every with a separate product focus). Properly, only a few weeks ago, the company announced the departure of its head of women’s apparel (the smallest division) and that Paul Andrew would take over. I believe it is a positive step in ensuring a unified and refreshed model. But, we’ll have to attend till early 2018 to see how much traction the brand new traces get.

On the executive staff, I like that the new CEO, Eraldo Poletto was very successful in growing his prior business (Furla). And, I respect his clear and logical plan for motion, upon taking over at Ferragamo. Lastly, throughout the new CFO’s tenure at Amplifon (which is publicly traded in Italy), the company considerably expanded sales, FCF, and EPS.

I’ll simply make one ultimate remark related to the above: someone lately prodded me a bit, asking how comfy I could actually get with the new management teams. While I famous the above factors, I also talked about that my investing fashion is to get involved early in conditions earlier than it becomes obvious what’s occurring (obviously at the risk of being unsuitable). My assessment of the state of affairs is that the chance/reward is favorable – but clearly, there are important risks that this doesn’t play out as expected.

***

Due to George for the interview. If you’d like to take a look at or comply with his work, you can find the profile right here.

Professional idea playing out

Detroit Bear said there was enormous draw back for Trevena (NASDAQ:TRVN) in December 2016 as a result of challenges in commercializing its lead drug candidate as hospitals would be unlikely to pay for a dearer product with only barely superior performance. Which is what happened because the inventory is down seventy five 75%. In an update article Detroit Bear attributed the poor performance to lackluster knowledge and stated there was still draw back (all the option to zero) as despite the recent headcount discount, TRVN will still be burning a big amount of cash and it appears potential acquirers have taken a pass.

Professional Weekly Digest idea playing out

In a previous version of the Professional Weekly Digest, we said the bullish name by Ivan K. Wu on Linamar (OTCPK:LIMAF) was value revisiting and since then the stock is up ~35% (in CAD), most likely as a result of continued strong results (see Ivan’s take on Q2 leads to an update comment).

Name from the archive – MGMXF

Alterra Energy (OTCPK:MGMXF) is down ~10% (in CAD) since Ivan Okay. Wu shared his bullish thesis in June 2017. Nevertheless following the latest optimistic earnings report (file 2Q technology, >20% increase in income/EBITDA, expects to increase dividend in 2018) and ~70% upside, this thesis may be worth revisiting.

Noteworthy Pro articles

In addition to the highest idea we published this week, we needed to spotlight a few of our Professional editors’ favorite Pro ideas this week:

SA Editor John Leonard, CFA: Bulls & Beards takes a important view of the recent leveraged recap at Greenhill (NYSE:GHL) as its issues are structural, not cyclical (and new debt only amplifies the dangers) whereas massive dilution limits upside even in the most effective-case state of affairs.

Mr. Bert makes the bullish case for Mammoth Energy Companies (NASDAQ:TUSK), an below the radar and quickly growing oilfield service firm centered on essentially the most engaging onshore shale basins buying and selling at only ~5x EBITDA with superior margins, a clean balance sheet and returns-oriented administration. The recent contract to rebuild the electric grid in Puerto Rico highlights the earnings energy of its new utility infrastructure enterprise.

Concept screen of the week

Every week we use the Professional Concept Filter to search out potential ideas based mostly on a recent information event. This week, Professional Editor John Leonard, CFA appears at beneath the radar development firms.

For progress traders trying to avoid the gang (or at the very least recognize a story before the crowd does), I ran a display screen of Pro long ideas with Progress because the Model and Underfollowed because the Investment Opportunity tag.

2 ideas turned up on this display that may be of curiosity (costs as of October 26 shut):

Juniper Pharmaceuticals (NASDAQ:JNP) by Boris Marjanovic: Revealed on October 26, 2017, ~unchanged since publication, writer’s value goal offers 40 forty% upside. JNP is a fast-rising feminine well being company trading at a discount to peers with a clear balance sheet, expanding margins and enticing R&D pipeline.

Tantech (NASDAQ:TANH) by Amit Ghate: Published on October 23, 2017, down ~5% since publication, author’s value target affords one hundred%+ upside. The promote-off following a comparatively small financing provides a sexy entry point into this electric vehicle play.

About the Professional Weekly Digest

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Disclosure: I/we haven’t any positions in any stocks talked about, and no plans to provoke any positions inside the next seventy two hours.

I wrote this text myself, and it expresses my own opinions. I’m not receiving compensation for it (other than from Seeking Alpha). I haven’t any enterprise relationship with any firm whose stock is talked about in this text.

Further disclosure: Test with particular person articles or authors mentioned for their positions. Of stocks talked about, Upslope and its shoppers are presently lengthy SFER:IM and CCK, and short OI. Upslope and its clients do not at present hold positions in: GS, TSLA, BMO, or Kering – nor does Upslope have any plans to initiate any positions in these securities presently. Upslope Capital Management, LLC (“Upslope is a Colorado registered funding adviser. Info presented is for dialogue and instructional functions solely and does not intend to make a suggestion or solicitation for the sale or purchase of any particular securities, investments, or investment methods. Investments contain danger and, except in any other case acknowledged, aren’t guaranteed. While Upslope believes all information herein is from reliable sources, no representation or warranty may be made with respect to its completeness. Any projections, market outlooks, or estimates in this presentation are forward-trying statements and are based mostly upon inner evaluation and certain assumptions, which replicate the views of Upslope and should not be construed to be indicative of precise events that may happen. As such, the data may change sooner or later should any of the financial or market conditions Upslope used to base its assumptions change. Any particular security or investment examples in this presentation are meant to function examples of Upslope’s funding process solely and may or will not be trades that Upslope has executed or will execute. There is no such thing as a assurance that Upslope Capital will make any investments with the same or comparable traits as any investments presented. The investments are presented for dialogue purposes solely and usually are not a dependable indicator of the efficiency or investment profile of any composite or shopper account. The reader should not assume that any investments recognized were or will likely be profitable or that any investment recommendations or funding selections we make in the future will likely be profitable. You shouldn’t depend on this discussion as the idea upon which to make an funding determination. Upslope is under and accepts no obligation to replace this dialogue or these supplies at a future date.

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