Q3 2019 Quarterly Portfolio Update

(July – September)

Q3 2019 was a fairly quiet quarter for investment activity. As I have been mentioning recently, a focal point of mine at this stage in the business cycle is to raise cash. I would like to have a nice stockpile of ammo to take advantage of any major market downturn when that happens. I don’t know when it will happen, but it will, and I intend to be ready to buy stocks “hand-over-fist.” I don’t consider myself skilled in being able to time the market and, as such, will stay invested through the cycle. This is merely tactical positioning as dividends roll in and I add new capital to the portfolio. As such, I am compiling a list of quality companies that I want to own but the market hasn’t given me attractive enough pricing yet.

In addition to raising cash I have been thinking a lot about what some of the major threats facing my portfolio are today. After investing through the latter half of a decade-plus long bull market, capital preservation is key. I believe the biggest risk that could create permanent impairment to my portfolio is inflation. As a hedge to macroeconomic and geopolitical risks, I added gold exposure to my portfolio during Q3 2019. My thoughts on this addition can be found here.

General Portfolio Updates

CVS       Pharmacy Benefit Managers (PBMs) and other healthcare players jumped in mid-July in reaction to the Trump administration’s reversal on its proposed overhaul of rebates collected by the drug middlemen. I am still down roughly 5% on my CVS holding but like the prices I have been to accumulate shares at and the dividend that I receive. The stock has bounced back as I was down over 20% at one point. I continue to think this is a solid long-term holding and I like the strategy the management team is taking to set the firm on the right track for the future. Eventually, I expect the company to start raising the dividend again. As mentioned previously I will likely be revisiting my valuation in the near future.

BAC       Buffet increased stake in BAC to 10%+. This has been a popular holding (along with some other banks) for The Oracle of Omaha. Buffet received a sweet deal on warrants back in 2011 and has profited significantly from this position. The idea that he is confident on the future prospects of this banking giant help provide me with some confidence in my holding. The firm is well-run and has provided significant shareholder returns since the financial crisis. They continue to buy-back shares, raise the dividend, and are well-capitalized. I am also a Bank of America client. Just like Peter Lynch, I am a fan of investing in what I know.

SBUX     Starbucks exceeded expectations and showed strong comparable same store sales growth in the US and continues its expansion in China/Asia Pacific. The stock essentially doubled since I initiated a position but has since pulled back a bit to the mid-$80’s. I won’t be adding at these levels since you’d really be paying up for future growth. However, I continue to like this company as a long-term hold. There is plenty of runway for dividend growth as well. Part of me wishes the price hovered around my purchase price for a bit longer so I could scoop more shares.

Q3 Buys/Sells

  • Buy – JNJ           
    • I first purchased Johnson and Johnson back in 2015. This holding is a cornerstone to the satellite portfolio and a position that I will look to continually add to when the market gives me a discount. The company is known for being a leader in the healthcare market and has been rewarding shareholders for years. Investors know this is a great company and, as such, it can be difficult to establish a position at discounted or even fair prices. Fortunately, during Q3, I was able to scoop up shares when the price dipped in July. This was likely a result of risks surrounding opioid lawsuits, trace amounts of talcum found in baby powder, and uncertainty facing drug pricing in Washington. JnJ is one of two corporates rated AAA by S&P (Microsoft being the other). I am happy to pick up AAA risk with a dividend yield of ~3%, a payout ratio of 60% and 1,3,5 year div. growth rates of roughly 6.5%. This is a best-in-class firm that produces a FCF margin of over 20%. I consider the price to be about fair-value and by no means think I’m getting a steal. But this is a stable and predictable business that should be around for a long time and providing its investors with consistent dividend growth. Since I like to focus on risk management as opposed to chasing returns, my thoughts on JnJ can be summed up with the following quote:

“My largest positions aren’t the ones I think I’m going to make the most money from. My largest positions are the ones where I don’t think I’m going to lose money.” — Joel Greenblatt

  • Buy – GLD (See above)
  • Sell – BBL (Reduced Position)
    • I mentioned in my Q2 quarterly that I was thinking about reducing my position in BHP Billiton. Given where we are in the economic cycle, the cyclicality of the company’s cash flows, and the firm’s reliance on commodity prices to create profits, I decided to reduce exposure by trimming my position by half. This slightly damages my dividend income as the stock yields close to 6% and my yield-on-cost was over 8%. However, I don’t like having one stock constitute such a large percentage of overall dividend income, especially when its cash flows are reliant on commodity prices. I thought it would be prudent to harvest some capital gains here.

Dividends

Q3 delivered the highest ever income received by the portfolio. Q3 2019 income was 51% higher YoY. I am very happy with the passive income growth realized by the portfolio and hope I can continue building income at a high growth rate.

The portfolio’s dividend yield is 3%. This is down slightly due to the elevated cash position and the dividend cut by Tailored Brands. (More on TLRD below)

Dividend Increases:

BAC +20% to .18 quarterly

UNP +10.2% to .97 quarterly

SJM +2.5% to .85 quarterly (Not great, SJM had a lax-luster performance this year/past quarter) The share price has been trading sideways.

WPC +.2% to $1.036 quarterly (This stock increases the dividend quarterly)

ORI – Paid a special dividend of $1.00/share (has done this annually since I’ve held it)

Tailored Brands

What a volatile month is was for TLRD! This stock demonstrates how emotional investors can be. The stock price dipped as low as $3.70 in early October and has since steadily climbed back up to the mid- $5’s. I am still holding on to a loss but the story continues to play out as expected. I believe that the turnaround is in progress and the excessive pessimism in the stock has created an opportunity. Given the riskiness of this play the position is a smallish percent of my satellite portfolio (approx. 3%) (See applicable Greenblatt quote above) but I may look to accumulate more shares if this continues to play out as expected. Here are some of the major highlights from the last quarter:

  • Michael Burry (Scion Capital) wrote a couple of letters to the management team telling them that their best use of capital was likely not to continue to pay out a dividend, but rather use FCF to pay down debt or buy-back shares. I mentioned in my initial thesis that the dividend I was receiving (12%+ yield) was nice, but I did not expect that to continue indefinitely. Management has since cut the dividend to focus on debt repayment and share buybacks. I am not certain if share repurchases have taken place yet, but we’ll likely find out on the next quarterly. I believe this was a good capital allocation decision.
  • More insider purchasing. EVP and General Counsel Alexander Rhodes bought 13,369 shares of TLRD stock in October (Q4. I know, I was late with this post) at an average price of $3.87. Director Theo Killion bought 15,000 shares of TLRD stock in September at the average price of $4.64. President and CEO Dinesh Lathi bought 44,000 shares of TLRD throughout September and October at an average price of about $4.50. Together, the executive team spent roughly $325,000 on TLRD stock.
  • Short interest still sits around 20%. Good news could set in motion a ‘short-squeeze’ that causes the price to jump.

Other

I continue to look for new investments to add to the satellite portfolio. With about 20 holdings across many different sectors I believe the portfolio is sufficiently diversified and I am not looking to make the portfolio much bigger in terms of the number of overall positions. Any new additions may result in me selling a current holding. This forces me to really evaluate the moves that I make.

There aren’t many positions currently held in my portfolio that I would add to at this point given their current valuations or relative size. I am mainly looking outside of the portfolio for opportunities. However, that is not to say that I find any of the stocks in my portfolio overvalued to a point that I’m willing to sell out. There is two or three positions that I would take profits in if I could substitute for a more attractive investment.

I continue to look for stable and predictable business models that hold a competitive edge and provide significant FCF that support an attractive dividend growth story. I also continually monitor the spin-off universe, tender offers, going-private transactions, and any other special situation opportunities that could present indiscriminate selling and/or attractive risk/reward profiles. Patience is key. If I can find 2-3 profitable opportunities each year while the portfolio continues to distribute a healthy income stream, then I am well on my way to financial independence.

-Pennybags

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