It has been a complicated year to navigate the markets. The S&P500 index declined 20%, and the Nasdaq lost 34%. 10 out of 11 sectors finished the year in negative territory, being Energy the only one on the positive side. Stronger-than-expected interest rate hikes and recession consensus were responsible for the bad performance of the main indexes.
Inflation deserves a special mention in 2022. Because of the post-Covid reopening, the Russian invasion of Ukraine and the billions printed in the last two years (among other causes) CPI reached 10% in Europe and 9% in the US. This forced Central Banks to rise interest rates (maybe too late, especially in Europe) and equities suffered a lot. The most impacted sectors were Consumer Discretionary, Communication Services and Technology. As it usually happens in this part of the cycle.
This was also the year that Europe adopted semi-communist politics against its energy sector to subsidise electricity bills. We believe that the implementation of the windfall taxes (more about it later) will have a medium-term impact on European energy security and electricity prices as energy companies are cutting their investments or leaving Europe.
Our portfolio has been significative impacted by that decision as natural gas in Europe was our main bet. Despite that, we finished the year with +32.4%. A bittersweet feeling as we were + 60% at the end of August. We analysed our decisions (good and bad ones) throughout the year and we believe that became better investors after it.
At the time of this writing, we are still thinking about the playbook for 2023. We will diminish the weight that the Energy sector has in our portfolio. Not because we believe that structural problems are solved (they are not) but because it was clearly overweight (as a response to Russian sanctions). We think neither the situation in the business cycle nor the market sentiment is the same now. In contrast, we are giving entry into the portfolio to sectors heavily punished in 2022. These sectors should recover in 2023 and perform better than the overall market as the impact of inflation eases. We have spent the last three months analysing companies in these sectors. We will publish an analysis about them soon as we are taking investment decisions about some of them now
Portfolio rotation in the 4Q22
Focusing on 4Q22, we made several movements, but the vast majority of the related to positions we already had in our portfolio. We doubled our position in IOG in October (just after the RNS release) and increased considerably our positions in Jadestone and Golar LNG. The only new company we added to our portfolio was OneWater Marine a serial compounder in the consumer discretionary sector. On the sell side, we sold Serica in the middle of the quarter and reduced a little our position in Adriatic Metals as it went up >50% in a quarter. We also traded Compagnie des Alpes which remained in our portfolio for around 6 weeks.
Serica: After the news of the new increment in the Windfall Taxes only five months later its imposition, we decided to diminish our exposure to European natural gas. Among all our positions, we chose to sell Serica. It was cheap on paper, but time passed by and their management was piling up the cash without taking any decision. We wanted to wait for North Eigg results knowing the 20-30% probability, but we felt more comfortable maintaining our other positions. Then, when weeks after we knew about the structure of its new deal, we felt an immense relief of having sold the position. Having such an amount of cash and structuring the deal with such a dilution… is more an empire-building thought than caring about shareholders.
During the quarter, we have been analysing several companies mainly in the consumer discretionary sector, but we have only added $ONEW at the moment of this writing. Apart from boat dealers, we are looking at wineries, restaurants and food producers.
Consequently, taking into account the adjustments done in the quarter, the portfolio on 31st December (Ordered by weight) was: Golar LNG, Jadestone, Kistos, Adriatic Metals, OneWater Marine, Vermilion Energy, IOG and The Italian Sea Group.
Comments about the companies in portfolio 4Q22
Golar LNG $GLNG
Golar finished the year without announcing any new FLNG contract. It penalised its share price which reached $21 during the quarter. However, the announcements that Golar made in the last months have been pretty positive. It bought back $140MM out of $300 of its 7% senior secured bond. Sold more New Fortress Energy shares and trimmed its position in Coolco.
Golar has become the infrastructure company that it visualised several years ago. Now it is reducing its holdings in other companies (New Fortress, Coolco and Avenir) obtained through its simplification process and working to obtain the new wave of FLNG contracts. In the meantime, it has Hilli producing 100% uptime and generating a pile of cash thanks to its TTF-linked production(and hedged at >$50MMBtu) plus the bonus Brent (starting at $60 Brent). Furthermore, in a few months (3Q23) the FLNG Gimi will start its 20-year contract for BP generating $151MM EBITDA net to Golar. Also, Golar’s debt has reduced considerably and the company is in a net cash position.
Therefore, we believe that it is a good place (undervalued company, net cash and a lot of optionality) to sit and wait for the news of new FLNGs. It has become the principal position of the portfolio again.
Apart from the investment thesis, we published an update on 3Q22 results
Kistos was impacted by the new Windfall taxes in the UK (the second increment in a year) and the rumours and final resolution in the Netherlands. Both of them are explained in the updated investment thesis of 27th November. Apart from it, the weather was milder than usual in October along with the forecast of warmer weather for 1Q23.
Kistos has been six months without announcing any movement, which is unusual for the Kistos’ management. We are aware they were in negotiations for a deal in exclusivity during the last months, but we thought we would have already news by this time, so we honestly do not know the results of those negotiations.
The announcement we expect for the coming weeks is the results of the infill drilling campaign they are doing in the Netherlands. This infill drilling is expected to add around 2000 boepd in the first weeks. Following the data provided by the Dutch government, production in some of the Dutch wells has declined considerably in the last months. We expect the infill drilling to compensate for these losses and add a little production to the 6000boepd baseline.
As time goes by, we are closer to May 23, the date when the bonds have a call option. We should remember that bonds are the only stopper before being able to repurchase shares. And knowing the background of the Kistos team, if the share prices continue at these prices and they do not manage to obtain a deal, it will be the solution they will pursue.
Jadestone has become our second position as we have added aggressively during the quarter. The company launched in August its share buybacks program and it is taking advantage of the low share prices to eliminate around 25MM shares (>5% of the market cap).
At the moment, Jadestone is producing half of its capacity because of the Montara incident. We expect the company to publish an RNS in January announcing Montara is back in production. We also understand that the result of the Stag infill drilling has been in line with expectations. However, we also expect an RNS in the next weeks about it.
The Montara news alone should send the share price back to levels before the incident. Furthermore, we believe that Jadestone will extend the current (and modest) repurchase program once it finishes (we estimate that it will happen in February).
In the medium term, Jadestone has two natural gas projects (Akatara & Vietnam) that require a considerable amount of Capex. We love the economics of both projects. They are our reason to be long-term investors and not only focus on Montara reactivation. We will publish a detailed article about the economics of these two projects in the coming weeks.
Adriatic Metals ASX.ADT
Adriatic Metal’s performance was the star of the portfolio in the last part of the year. We also published our analysis of the company very recently, so there is little to add to that. The Vares project will enter production in 3Q22 and the forecasted prices for Silver for this 2023 are quite compelling. Apart from having a project with incredible economics, we like a lot the management team. They not only are starting production in record time but also are completely aligned with shareholders (communicating well, buying shares after steep declines…). Moreover, the management has already stated that once the Vares project is in production, they will look for more opportunities in the outskirts of the European Union.
OneWater Marine $ONEW
We knew about OneWater Marine in April, and it caught our attention soon. We tracked and analysed it for months and finally added it to our portfolio in Q4. OneWater Marine is a serial compounder growing revenues by>33% CAGR in the last five years. It operates as a boat deal taking advantage of the fragmentation in the industry and succession issues. $ONEW acquired ten companies last year, and its debt rose to 2x EBITDA. It is showing astonishing resilience to the business cycle (it is even increasing its sales) as a considerable part of the business acquired is anti-cyclical (maintenance).
Nevertheless, OneWater Marine is trading as if apocalypses happen tomorrow. Its CEO and main shareholder is adding shares, and we believe that we are in that part of the cycle where it is starting to be interesting to add companies like $ONEW to our portfolio.
We published a detailed analysis of OneWater Marine and another post analysing its 4Q22 results.
Vermilion Energy $VET / VET.TO
Vermilion Energy is the company that more headaches are giving us. It has been heavily impacted by the application of Windfall Taxes in Europe. Especially in Ireland, where the Irish government has imposed an outrageous 75% WFT. Ireland has one field that produces natural gas, Corrib. Vermilion owned 20% of this field in 2021. However, it acquired another 36.5% interest in the field, with the economic interest starting in January 2022. The price of the operation was $600MM. But the natural gas sold in January 2022 diminish the price of the operation. Applying 75% retroactive WFT in 2022, plus maintaining it for 2023 and 2024, destroys the operation. Vermilion has stated that it will not allocate Capex to it, and the decline rates in this field are north of 10%. Consequently, it is easy to see how bad the operation looks after the intervention of the Irish government.
Furthermore, Vermilion released its 2023 guidance this Friday, and we are a bit disappointed with the lower production range and the new Capex increment. We dedicated the last two entries in the blog to talking about this.
IOG had a tough quarter as its share price collapsed in October when it announced production had to stop for a month. At this point, we doubled our position in a speculative movement. They moved quickly and replaced the CEO and COO in what we believe was the correct movement. The share price partially recovered when production started again in late November. On the positive side, the hedges for December and January were signed at good prices. On the negative side, the market expected the announcement of Southwark entering production at the end of December. But, it was delayed until mid-January.
We like the “new” management as it communicates clearly to the market and shows investors that there is a plan supporting each movement. However, we remain worried about the water issues at Blythe
The Italian Sea Group BIT:TISG
The Italian Sea Group has performed pretty well in the last months. As we analysed in the 3Q22 earnings commentary, the backlog and margins are increasing, and it is managing well the inflationary pressures. The integration with Peroni Navi is well advanced and they are already building several yachts of this brand. We should note that the Italian Sea Group business is radically different from the one of OneWater Marine despite selling boats. TISG sells mega yacht (>100m in length) and its target are the ultra-rich segment of the population.
At this moment, we have limited exposure to this company as we reduced it last quarter. However, we like it and the sector and we are analysing if increasing our exposure to TISG / the sector. In fact, we are currently analysing San Lorenzo, its only Italian peer and we plan to publish it next Sunday 15th January.
Comments about other assets in the portfolio in 4Q22
We maintain our position in all the three funds we had at the beginning of the quarter
- Ishares Developed Real Estate Index (35%)
- MyInvestor Nasdaq100 (35%)
- Vanguard Emerging Markets Stock Index (30%)
We believe that this can be a good year for all of them, but especially for emerging markets, consequently, we have increased this holding in the last weeks.
Our views about Bitcoin has not changed a lot in the last three months. We have not done any movement and the price of it has traded flat. We plan to continue holding them in 2023 and learning more about it. As stated in previous quarterly letters, it is not a very relevant position in the overall portfolio, and we feel comfortable with it.
We survived a difficult year in the stock market thanks to the energy sector. However, we have decided to diminish considerable our exposure to this sector in 2023 as we believe that the situation is not the same as it was one year ago. We are rotating into sectors that have suffered a lot due to the rise of inflation, but they should perform better in 2023.
Probably, we will reduce our energy exposure to our core positions plus what we consider special situations. These proceeds will go into the consumer discretionary sector along with more defensive positions.
It does not mean that we believe that inflation is going to disappear soon. We contemplate the possibility of having another wave of inflation in 2H22. Nevertheless, we want to have a more balanced portfolio. Our central scenario is for inflation to continue reducing slowly and for central banks rising rates a bit more. The US economy has shown to be resilient and it is a double edge sword, as maybe FED continue raising interest rates in 1H23 and the recession is worse in 2H23.
We need to be prepared for another interesting year. The beginning has not been good as our natural gas thesis is having a bad time due to milder-than-usual weather in Europe. Nevertheless, we are positive for the future as we believe we have pretty clear the new asset allocation. We are finding interesting gems and our core positions are net cash and buying back shares. So we hope to deliver good returns also in 2023.
Apart from that, we are working on several fronts to move this project to the next level. We still do not know if we will be able to continue sharing the portfolio performance quarterly, but we will do the possible to continue doing so.
Looking forward to sharing with you our thesis & articles in 2023