Dear investors and well-wishers,
The Fund returned +2.9% in April 2019, ahead of the S&P 500 (+1.8%) and ASX 200 (+0.2%). This took our net return since 1 January 2019 to +19%.
Shorts were a positive, though minor, contributor (+0.1%).
Stanmore Coal has recovered since month-end after reporting $63 million of operating cash-flow and working capital release during the March quarter. This represents about 20% of their current market capitalization.
A few things to look forward to in 2019
A number of our portfolio companies are going through transformational periods over the coming 12 months.
1. Completion of Cooper Energy's Sole Project
As written previously, we purchased Cooper Energy at a 2020 EV/EBITDA of around 2x. Cooper Energy’s new gas project in Victoria is now 93% complete, and the first gas is expected in May. The multiple has expanded to 4.4x, and may well increase further when Sole is switched on. Irrespective of where the multiple trades from here, the firm will begin generate well over $150 million of EBITDA annually throughout the '20s.
New commodity projects can create a huge amount of value and attract plenty of stock market attention, the problem is actually pulling them off.
The most striking elements of the story is that management has kept on time and within budget, a rare achievement, and a reason for continued support as they turn their attention towards investing the next decade of cash flows.
The majority of their production has been sold forward in take-or-pay contracts to local blue chip counter-parties like AGL, so we are comfortable with the gas price risk.
2. First production from Lundin Petroleum’s Johan Sverdrup project
Lundin Petroleum is in a similar position to Cooper Energy. The firm has existing profitable
production, trades at ~7x historic EV/EBITDA, and is in the later stages of its own transformational new project, the Johan Sverdrup field in Norway.
Johan Sverdrup is 85% complete, with first oil due this November. Lundin's reserve replacement ratio is running at 165%, meaning they found substantially more oil last year than they produced.
The firm is listed in Sweden and with all its energy assets in Norway, we can be assured of solid governance.
Over the coming year we expect the firm to trade up from a 4x 2020 multiple to where it is now, at around 7x, which would involve a substantial rally in the shares.
Lundin Petroleum's forward EV/EBITDA multiple (light blue), and forward EBITDA (dark blue)
As with Cooper Energy, once the new project cash flows begin, the firm can create shareholder value without a change in multiple. In this case, the firm pays dividends as well.
To reduce the commodity price risk we have built a small short position in WTI oil, selling into the recent rally at progressively higher prices.
As you can see from the chart below, an energy company creating value can vastly outperform the underlying commodity over the long term, though day-to-day they track very closely.
Lundin Petroleum (blue, LHS) vs USO, a WTI crude oil ETF (RHS)
Given that Lundin is increasing production from 81 million barrels of oil per day to 170 million, we expect the out-performance vs crude to continue.
3. bluebird bio’s first approval, for beta-thalassemia
bluebird has long been our favoured gene therapy player. The European Medicines Agency recently recommended approval of the company's first treatment for beta-thalassemia, a genetic disease that causes excess iron to build up in the blood, damaging organs. The only current treatment is a lifetime of blood transfusions.
bluebird’s Phase I trial showed 15 out of 20 patients no longer required transfusions, and maintained this at last contact after 2-3.5 years. In their most recent Phase II/III, ten out of eleven patients under an improved regimen no longer required blood transfusions. This is the sort of data that we find convincing (relative say, to Biogen's work in Alzheimer's).
The estimated cost savings per patient are estimated at $3-4 million, allowing bluebird to charge up to $1.5-2m per patient and still net significant savings to the global medical system.
bluebird plans to share the risk with end-payers, and will only charge when a patient is cured. Peak sales may reach well over $1 billion, at at high margins too, as drug development costs are largely incurred up front.
The company is an attractive M&A target, offering a one-stop shop for pharmaceutical companies looking to build out a gene therapy franchise. Our portfolio companies of Avexis, Celgene and Juno were all bought out over the past year or so, and we wouldn’t be surprised to see bluebird attract a bid once their first treatment is approved.
Bluebird’s other programs are also on track:
All of bluebird’s 14 treated patients in Phase I/II of a sickle cell disease therapy demonstrated anti-sickling haemoglobin, and after six months, none experienced the most common pain attacks.
Sickle cell disease causes severe anemia, pain and reduces lifespan to ~44 years. The disease is common, with 300,000 - 400,000 sufferers globally. The gene involved is suspected of defending against malaria, so as you might expect, is very common in those with sub-Saharan ancestry.
bluebird has success in cancer too. When we initially invested, we ascribed no value to this part of their pipeline and considered it pure upside. Yet in multiple myeloma, bluebird’s second generation CAR-T treatment resulted in an 83% response rate in a heavily treated group of 12 patients. In an earlier trial, 50% of patients recording a complete response.
All these treatments are third or fourth line treatments after patients have relapsed a number of times and been through multiple rounds of grueling chemotherapy, so these results are remarkable.
Their real opportunity in oncology is to move the therapy up to earlier stages of treatment, and the firm is working with Celgene on the next generation of the technology.
We first purchased at around $76 and wrote about it here. The company has come a long way since, and our initial thesis, that early stage trial success would be replicated in later studies, has so far proven correct in each of the main programs.
We have entered a small short in the biotech index to manage the risk of a sector-wide sell-off.
bluebird bio (LHS) vs IBB a biotechnology index ETF (RHS)
Bluebird bio’s cash burn was $460 million last year, but with $1.9 billion remaining, they have sufficient resources to fund all their clinical programs.
There are ways to create value without showing historic profits.
Outlook and Positioning
We maintained a low gross and net position throughout the quarter. Many of the largest US tech stocks, which comprise of the bulk of US stock indices, are still below their 2018 highs. A continued rally there would cause the market to break to new highs.
Risks are also starting to reassert themselves, so we''ll continue to use hedges like those described above to isolate value creation from the market.
The burst of IPOs underway in the US (Lyft, Pinterest, Zoom, Slack, Palantir, Airbnb and Uber) is particularly ominous. The billions of dollars funding these IPOs come directly out of other parts of the equity market, and these often signal tops. The boom in biotech IPOs last year presaged the swift fall across the sector in the final quarter.
Yields have risen from their lows, and the price of gas at the pump is back at levels which sparked significant falls last year. We’re responding by running a far lower equity exposure than usual, while maintaining all of our concentrated, high conviction positions.
Most of our short exposure is in sectors, such as an equal weighted US retail index. This has leveraged department stores, traditional auto dealerships, and discretionary consumer businesses in areas like camping, a handy counterweight to our investments in retail disruptors like Amazon and Carvana. Both of these are growing faster and creating more value than the retail sector and indeed, the market itself. In effect, we’re investing in fast-growing innovators while betting against those from whom they're taking market share.
We are new shareholders of Amazon, purchasing near the lows in December 2018, but the stock’s out-performance over the retail sector both since, and over the mid term, has been striking:
New economy indeed.
Best wishes Michael
Our fund is available to wholesale clients, and the online form can be accessed using the button above. Please feel free to contact me directly for further information.