John Burbank’s Passport Capital did not have the best year in 2014. The flagship Passport Global Fund was down -0.4% in the last quarter, finishing off the year at just +0.9%, according to performance updates seen by ValueWalk. At the same time, the Passport Special Opportunities Fund was down 1.1% for the quarter, bringing its net return for the year to +9.9%.
Passport gains big in January
However, Burbank got off to a good start in 2015, as the Passport Global Fund grabbed a 9.2% return in January, and the Special Opportunities Fund saw a 17% gain the first month of 2015.
Passport Capital, which has significant exposure in the technology sector, was stung in most of its positions. According to the latest update, the China-based Vipshop Holdings was the lone performer last year as other positions in the internet sector lagged behind. The letter said that Vipshop is well-positioned in the Chinese internet retail market and that its discounted prices give it an edge over competing retailers. Vipshop is also the leader in apparel sales in China and has established a customer base even in the smaller cities of the region. Passport said that Vipshop will continue to perform well with its superior distribution and delivery services.
John Burbank shorts crude oil at end of 2014
The fund’s best performing positions were longs in Consumer Discretionary, whereas the worst performance came in metal and mining shorts.
Another of Passport’s problematic positions was its holdings in Saudi Arabia, where the stock market declined by nearly 30% in the fouirth quarter. Towards the end of 2014, Passport established net short exposure in crude oil, but maintained its long in Saudi equities. The fund also expanded its long weighting in the U.S dollar by pairing shorts in euro and Japanese yen. A stronger U.S dollar is a key theme in Passport’s positioning, the fund thinks that this strength will once again make the developed markets outperform the emerging world. John Burbank is bearish on commodity-exposed currencies and equities and said that a rising dollar will prove to be a headwind for commodities.
Higher price volatility, lower demand for high-yield assets
With the onset of the Fed taper and the rally in treasuries, John Burbank thinks that the rosy times for weak companies will come to an end. In the fund’s assessment, 2015 will mark the rise of companies that have strong balance sheet. Similarly with tightening financial conditions, high-yield assets might be in for some troubled times, said John Burbank. The fund further said that with the removal of Federal Reserve’s hand from the markets, asset price volatilty is likely to edge up throughout the year. Passport is also looking closely at price movement in crude oil, as crude price movements will likely have a significant impact on the risk regime of the markets.
The five largest positions of thed Passport Special Opportunities Fund are, CF Industries Holdings, Vipshop Holdings, Cytec Industries and Saudi equities, National Commercial Bank and Al-Tayyar Travel Group. National Commercial Bank is a new position for Passport Capital. The fund said that the Saudi bank has a low loan-to-deposit ratio and is one of the most liquid companies on the Saudi stock exchange. Burbank believes that the stock is underowned and will leg up when the Saudi market opens to direct foreign investment later in 2015.
Passport Capital manages $4 billion, whereas the Passport Global fund finished the year with $1.7 billion under management (currently $1.9 billion), according to the latest HSBC Hedge Weekly.
See both letters to investors below
Passport Global Letter
Dear Passport Global Investor:
For the fourth quarter, Passport Global (the “Fund”) declined by -0.4% net versus the MSCI AC World Index which appreciated +0.6% and the S&P 500 which appreciated +4.9%. Since inception in August 2000, the Fund has compounded at 17.5% net; over the same period, the MSCI AC World has compounded at 4.3% and the S&P 500 has compounded at 4.6%.
On December 31st 2014, the Fund held three private investments in a Special Purpose Vehicle (“SPV”). The SPV comprised less than 1% of the Fund’s AUM (approximately 1% for Class A investors) and detracted approximately -0.1% for the quarter.
Q4 & 2014 Global Portfolio Commentary
During the fourth quarter, the Global strategy had a daily annualized standard deviation of 13.9%. This compares to the MSCI AC World at 10.2% and the S&P 500 at 13.2%. For the year, the Global strategy had an annualized standard deviation of 11.9%. This compares to the MSCI World at 8.9% and the S&P 500 Index at 11.4%. The average beta to the Russell 2000 during the fourth quarter was 0.08.
In order to put 2014 into perspective, we’ll begin with a review of the salient events of 2013. Recall that in the second quarter of 2013, Bernanke announced the Fed’s intention to taper bond purchases. The signaling effect to investors was that private sector deleveraging was coming to an end, bond purchases would eventually conclude and, thereafter, rates would be begin to normalize and rise. Investors concluded that the Federal Reserve had confidence that escape velocity was approaching or that, at a minimum, growth would be sufficient to obviate the need for further accommodation. The net result was an immediate and dramatic regime shift in the type of assets investors preferred. Investors shed low beta assets aggressively over concerns that rates would move higher, and for the first time in several years, price momentum shifted from low beta, yield-oriented assets to high beta, growth assets. Treasury yields backed up, bond funds experienced meaningful outflows through the remainder of 2013 and equity funds saw over $300 billion of inflows—the largest in many years.
From the end of May 2013 through late February 2014, a strong regime for risk assets was dominated by growth securities, with the growth factor staging an impressive 20%+ gain. We took advantage of this regime shift via a large allocation to Chinese and U.S. Internet stocks, which amounted to our largest sector allocation over this period. By late February, however, the global macroeconomic reality began to take center stage: growth dependent on China infrastructure disappointed, as China’s transition away from fixed asset investment and towards consumption was negative for commodities and contributed to lower overall levels of growth. Europe’s economy struggled and the specter of deflation loomed large. In the U.S., markets began to discount the end of QE, assuming financial conditions would tighten and U.S. equities would be valued on fundamentals. At the start of 2014, 30 year U.S. rates were at 3.97% and then finished the year at 2.75% for one of the best asset class returns of the year. As the year progressed, the tone became more and more “risk off”, despite equity index returns still being positive. In the Russell 1000, high beta stocks underperformed low beta stocks by 18%. Low beta was led by utilities, which as a sector appreciated over 29% during the year. Health Care, REITs, and Staples were the other dominant performers of the year. With the exception of Biotechnology, most of the sectors that experienced strong multiple appreciation last year are generally characterized by low returning, “safe” assets. High dividend yield stocks outperformed low dividend yield stocks by 7%, while high growth stocks underperformed lower growth stocks by 9%. As 2014 progressed, investors unwound a lot of the enthusiasm prevalent in 2013 and went back to investing in bonds and equities that were generally perceived as “safe”. “Safe” equities are not typically a fertile ground for strong returns. However, given the macroeconomic shifts, multiples for “safe” equities increased well beyond expectations in an environment where Treasuries rallied sharply.
China Internet, which appreciated approximately 100% in 2013, lagged in 2014. Aside from strong performance by VIP Shop Holdings (VIPS), our largest technology position, there were more losers than winners in technology during 2014, as higher beta, growth assets suffered. We benefited from longs in Consumer Discretionary and shorts in Metals and Mining. During the second half of the year, we were hurt by Energy and Saudi Arabian longs. Crude peaked in June and declined slowly until October when the pace of decline began to accelerate. In mid-October, we observed falling rates, declining oil and low beta outperforming; it was a significant macro inflection with wide-ranging implications. While it took time to assemble the pieces, by late November we positioned ourselves short crude oil, added to our long allocations in both short and long duration rates and went much longer the dollar via short JPY and EUR. The dollar rallied over 10% in the second half of the year. As a result, we were able to weather declines in many core longs—including the Saudi market correction of over 30% from September to the middle of December. Our macro positions served to offset losses in our equity book during the fourth quarter.
After five years of aggressive stimulus by the U.S. central bank, 2015 appears to be the year where monetary easing yields to monetary tightening. We don’t believe that equity investors fully appreciate the implications this may have on equity prices.
Our views and observations for 2015, and resultant investment implications, are summarized below:
We expect 2015 to be the first year in many where high quality equities dramatically outperform. A
proxy for thinking about this is corporate balance sheets. Weak balance sheet companies have
dramatically outperformed since the inception of QE in the US. We think that trend should begin to
reverse this year as U.S. dollar liquidity is drained from the system.
We think a rising dollar will continue to tighten financial conditions and that as this happens, lower-quality equities could underperform. If we are right, this could be a good year for security selection alpha on both sides of the portfolio. A robust high-yield market has generally aided lower quality companies. With the collapse in crude prices, we believe high yield should be far less of a catalyst for low quality this year.
We believe this is the year to be aggressive on idiosyncratic shorts over indices. We sense a large disconnect between prices and what our macroeconomic view suggests is coming. Our perspective is far from consensus. Crude’s collapse in the second half of the year ushered in a powerful regime shift, and we think it will take time for investors to process its importance and meaning. Two of the biggest demand sources for equities in the past few years have been companies themselves (through buybacks) and sovereign wealth funds. With many oil-exporting nations now moving from robust surpluses to deficits, we expect many sovereign wealth funds will turn from large buyers of equities to sellers. And it is flows on the margin that determine risk appetite. Approximately 9% of forecasted S&P 500 buybacks are in the energy sector, much of which we belive is at risk.
We think asset price volatility should increase sharply. For the past five years, the U.S. Federal Reserve has suppressed asset price volatility and reduced the risk premia associated with risk-free assets through QE. We believe that trend is beginning to reverse. Increasing asset price volatility should be a powerful aid in improving the stock selection opportunity set and dispersion. We started to see this in the fourth quarter of 2014 after QE ended. We expect increased quantitative factor volatility as well as asset price volatility. Whereas rallies often happen over long periods of time, declines are often sudden as prices can fall dramatically.
2014 began with high beta assets outperforming, but transitioned quickly to low beta assets greatly outperforming. It is rare to see the pendulum swing back to high beta without a distinct catalyst. Usually, the subsequent events would be rising asset price volatility, continued underperformance of high beta, rising correlations and then dislocation, as fundamentals re-price so that high beta securities become attractive again. But so far in January, we’ve seen an acceleration in the factor trends of 2014. Through January 28th, high beta is already underperforming by 8% and price momentum (currently biased towards defensives) is up 8.5%. This is remarkable in light of the fact that, historically, one of the strongest seasonal trades is the January reversal whereby the prior year’s underperformers dramatically outperform. From a factor perspective, that presently is not occurring.
We expect that what worked in the latter half of 2014 will continue to work and perhaps even accelerate. As a result, we currently have a continued preference for large, liquid, safe, low-beta assets, high dividend yields and expect underperformance in higher beta, riskier assets.
So far, the end of QE has followed the pattern of prior QE endings. The end of QE has been characterized by falling rates, lower inflation expectations and the underperformance of high beta assets. In prior cycles, typically this has subsequently led to further easing and rising inflation expectations. We’ll be carefully watching for inflation expectations resulting from any QE decisions by the ECB.
Crude oil is having a strong impact on the risk regime. On days crude is down, price momentum is generally positive and beta is negative. Likewise, when crude rallies, beta generally outperforms and price momentum is negative. This relationship has only become stronger in the last two months, so if it breaks down it is something we plan to monitor closely.
We continue to believe long rates are one of the best ways to express our view that disinflationary conditions are presently a big risk. And in an environment where European and Asian fixed income yields are so compressed, we believe there will be tremendous demand for long-duration fixed income in the U.S.
We believe this year will offer the opportunity to generate outsized returns. To that end, we intend to run a more elevated amount of risk relative to the prior few years-toward the higher end of our target range—given our present level of conviction.
Macro Review and Outlook
Since late 2011, we have held the view that global GDP growth would be weak and generally disappoint consensus expectations. We have also expected that the rate of change in technology, businesses and economies would be high and led by the developing world, specifically the U.S. Our view is based on many inputs, but a few key considerations include:
China’s economic evolution
Weak impact on GDP from global monetary policy
Deflationary impacts of technology
The vastly improved environment for corporate governance—particularly in the U.S. —where nonaccretive capital expenditure has been scrapped in favor of higher margins and returning capital to shareholders.
China GDP growth has been slowing as it transitions its economy towards domestic consumption, as much of the developed world did in the prior two centuries. Progress is finally being realized, as China printed a 7.4% real GDP growth rate in 2014. But this shift has been hard on many commodity producers, who bear the brunt of the pain. Many commodities were negative in 2014, including iron ore, copper, met coal and steel which were all down double-digit percentages.
We have observed that Federal Reserve monetary policy, despite a quadrupling of its balance sheet from late 2008, has had a limited effect on GDP growth. What it has accomplished, however, is a re-pricing of virtually all financial assets. In our view, part of the limitations of central banks is their inability to model economic changes resulting from technological innovation. We believe the deflationary effects from technology are significant and have likely contributed to slower employment growth than expected, compelling the Fed to remain active for longer than they had hoped.
A key development in the U.S. over the past several years is the marked improvement in corporate governance. We have described it as a high level of management sobriety, which is very different than the decade prior to the financial crisis.
A year ago in our Q4 2013 letter, we expressed three primary themes driving portfolio construction:
(1) The market’s recognition of a slower growth world;
(2) A bias toward developed markets over emerging markets; and
(3) A preference for equity over credit.
A review of how these themes performed in 2014 helps frame how we are positioning the portfolio as we begin
2015.
Investors appear to have spent much of 2014 arriving at the realization of slower growth around the world. Brent Crude was down 48% last year, as was iron ore. Copper was down approximately 17%. Lower growth expectations were reflected in investor’s preference for safety: U.S. Treasuries did quite well, as the 30-year started at 3.97% and ended at 2.75%, and the 10-year began 2014 at 3.03% and ended at 2.17%. As discussed earlier, high beta and growth equities were weak in 2014 after starting the year incredibly strong.
Developed markets—led by the U.S.—outperformed emerging markets. The MSCI World ex-EM Index was up 5.6% while the MSCI Emerging Markets Index was down -2.1%. The S&P 500 appreciated 13.7%. There were a variety of factors that contributed to positive flows into U.S. equities, including massive corporate buybacks, strong and stable dividends, higher levels of liquidity compared to global equities and a relatively stronger economy. This led to another year in which developed markets outperformed emerging markets, despite the economic and political challenges in Europe and Japan.
In 2014, equity outperformed credit as the S&P 500’s return was unmatched by Investment Grade Bonds (LQD ETF), which rose 8.2%, and High Yield Bonds (HYG ETF), which rose only 1.9%. The positive performance for credit came primarily from the sharp decrease in Treasury rates as both investment-grade and high-yield spreads widened significantly in the second half of the year.
Looking ahead to 2015, we are positioned for an even stronger U.S. dollar with the Fed on a tightening path and Japan and Europe pursuing QE. We believe these trends will likely act as headwinds for commodities, emerging markets and global GDP growth. A summary of our primary investment views follows:
Rising U.S. Dollar: A stronger dollar is a tailwind for U.S. assets. Yields in Treasuries, despite a considerable decline, are still well above bond yields in Europe or Japan. We think they will continue to fall, despite nearrecord short interest in the 10-year from investors expecting an improving economy. We are presently short the Yen and the Euro but recognize they will behave differently in different environments, as the yen tends to rally on risk-off moves while the Euro is on a downward trajectory set in motion by the ECB. We believe other commodity currencies will continue to weaken, and as a result leave most commodity equity shorts unhedged on a currency basis.
Declining Rates: As 2015 has begun, many seasoned fixed income investors expect yields of 10-year and longer Treasuries to fall. But we are of the view that U.S. rates will be lower across the curve. We believe the Fed will find it difficult to raise rates as many times as expected; as such, we are long the 1-year rate two years’ forward (2y1y) with the view that, while there will likely be one or two rate hikes, it will be fewer than investors presume (and prices reflect), as the impact from a stronger dollar could alter the number of hikes that the Fed will likely execute.
Falling Commodities: While we have been short industrial commodities since late 2011, we were caught offside by the decline in crude oil in the second half of 2014—last year’s black swan event. By Q4, however, it had become apparent that OPEC would maintain output, as Saudi sought to punish Russia and Iran for their support of Syria and reduce the threat from North American shale oil production. Just before the OPEC meeting in November, we shorted crude in part to express this view and in part to hedge our long Saudi equity position; we maintained this position into year-end. It is remarkable how energy equities held up so much longer than the price of crude; in our view, the equities were pricing in a V-shaped recovery for the oil price. We maintain our Saudi long exposure based on the views that 1) Saudi has the reserves to fully fund its budget for many years without relying on a dollar of incremental oil revenues, 2) the Saudi stock market will open to foreign direct investment likely sometime in the middle of this year and 3) despite four years of strong performance, Saudi equities are very attractive by virtue of intrinsic, strong growth rates and inefficient prices driven by a market that is largely dominated by domestic, retail investors.
Developed Markets (U.S.) over Emerging Markets: For the bulk of our equity exposure, there is a preference for large cap, U.S. dollar-denominated companies, particularly companies with high potential for buybacks or otherwise returning capital to shareholders. We have a preference for companies with strong cash flow generation, strong corporate governance and growth. Our shorts, however, are generally very dependent on global GDP growth or hurt by a strengthening dollar. We are also short certain companies that are commodity price-dependent or highly levered, a factor that we think now suffers in an environment of tightening financial conditions.
The deflationary re-pricing of assets is not unusual. But the way it is happening and the magnitude at which it is surprising investors is certainly unusual. The price of oil is a good example. Brent crude has now fallen from $110 to under $50/bbl. At first the price decline was gradual, but starting in October it picked up speed. Investors have traditionally linked a falling oil price to positives for the U.S. economy, consumer spending, etc. But as a result of the growth in shale production, the energy sector today represents over 14% of the U.S. highyield credit market. And since the crisis, much of job growth in the U.S. is attributable to the energy sector. So we have an open mind as to what the oil price decline is going to mean for the U.S. economy, U.S. equities and economic growth. In any case, we do not believe that QE in Europe or Japan will cause investors to be more risk-seeking.
The fulcrum point of this year could be the Fed. In our view, QE3 did not accomplish price stability (i.e., inflation) or job growth, and it appears that now the Fed would like to unwind it. It has stated its intention to raise short term rates in the face of improving economic data. But this certainly does not conform with our view of global deflation.
It is possible that the risk aversion currently expressed by investors in the U.S. market may reverse should investors believe the Fed will no longer tighten rates. If this were to happen, we expect the 2y1y will act as a hedge against our short portfolio, as the 2y1y is discounting multiple rate hikes over the next several years. But first, we will likely need to get through one or two rate hikes which would imply that the switch to risk-seeking may take time.
We think this is the best macro investing environment we have seen in quite some time, and we are more excited about our prospects than we have been in several years. The difference between QE-enabled markets in Europe and Japan and the prospects of tightening in the U.S. is leading investors to different prices and conclusions. We believe that the opportunity to profit from longs and shorts in equities, currencies, rates and commodities is quite compelling. As a result, we currently expect our portfolio to run at the high end of our risk budget for much of the year.
Business Update:
Capital Flows: For the fourth quarter, the Fund has net outflows of $47 million firm-wide, net inflows totaled $16 million. At quarter-end, fund assets stood at $1.7 billion and firm assets totaled $4 billion.
We appreciate your continued confidence and encourage you to contact us with any commments, questions, or observations.
Sincerely,
John Burbank
Chief Investment Officer
Bill Nolan
Director, Marketing & Client Services
Passport Special Opportunities Letter
Dear Passport Special Opportunities Investor:
For the fourth quarter, Passport Special Opportunities (the “Fund”) was down -1.1% net versus 0.5% for the MSCI AC World Index and 4.9% for the S&P 500. Since inception in May 2008, the Fund has compounded at 11.9% net on an annualized basis. Over the same period, the MSCI AC World has compounded at 4.1% and the S&P 500 at 8.5%.
As of December 31, 2014, the assets under management of Passport Special Opportunities and the assets managed by Passport Capital, LLC (“Passport”), were approximately $452.3 million and $4.0 billion, respectively.
For the quarter, equity longs detracted approximately -10.7% and shorts contributed approximately 10.3%, on a gross basis, respectively. Non-equity investments detracted approximately -0.3% gross.
At quarter-end, the Fund held 13 positions long, 11 positions short and seven private investments. The delta-adjusted, mean-weighted market cap of the public long portfolio was $12.3 billion and the short portfolio was $10.5 billion.
Review of Top Holdings
On December 31, the top five public equity positions in the Fund accounted for approximately 71% of the Fund’s NAV.
A brief update on each of these positions follows:
CF Industries Inc. (26% of NAV): CF manufactures and distributes nitrogen fertilizer products primarily in North America and had a $13.6 billion market capitalization at quarter-end. The company benefits from cheap U.S. natural gas prices, relative to competitors using expensive gas in Europe and coal in China. Additionally, CF recently appointed a new CEO who appears quite interested in delivering value to shareholders. We believe the company will follow through on announced plans to return capital to investors via share repurchases and increasing dividends. Since the end of 2011, CF has reduced share count by approximately 30%. Currently, the company has authorized a one-billion dollar stock buyback program, which may be expanded in size with a potential new debt offering. Additionally, the dividend has increased from $0.40 per year in early 2011 to an annualized amount of $6.00 in the third quarter of 2014. This is an important secular change in corporate governance. We expect even more capital returns to shareholders as they expand their production capacity by 25% due on-line in early 2016.
Nitrogen fertilizer prices remain in the middle of their long-term average. Currently, multiple production outages at competitors in other countries have kept nitrogen prices at mid-cycle levels. These outages are mostly structural in nature due to declining natural gas reserves, politics or war. We believe this should be accretive to EPS going forward.
We also believe CF is going to consider introducing MLP structures, which could have the effect of enabling collective corporate assets to trade at much higher valuations.
Vipshop Holdings Ltd. (21% of NAV): Vipshop (“VIPS”) is the leading online discount retailer in China. The company provides popular, branded apparel and other products at significant discounts from retail prices for mass consumption.
Apparel is the largest online eCommerce category in China, and we think VIPS represents an attractive way to gain exposure to this rapidly growing market. According to a Bain & Co. report, Chinese consumers spent approximately RMB 1.3 trillion on online purchases in 2012, which represents a growth rate of over 70% per year since 2009. Bain & Co. expects Chinese eCommerce to reach RMB 3.3 trillion by 2015, which equates to a 32% annualized growth rate from 2012 to 2015. It was estimated by the McKinsey Global Institute that in 2013, China eclipsed the U.S. in dollar-value of eCommerce transactions.
Many apparel brands in China have large inventories due to complex, multi-tiered distribution channels and very high gross margins. This, paired with the fact that large brands typically are able to sell volume quickly to raise cash, attracts many brands to move inventory through VIPS’s website.
In turn, Chinese consumers are drawn to the site due to deep discounts to the regular retail prices of authentic products and popular name brands. VIPS is able to deliver discounts due to their lower-cost business model that is not reliant on a physical storefront presence. Additionally, VIPS reaches a large consumer base outside of major Chinese cities, as the vast majority of China’s consumers are pricesensitive and seek opportunities to access products at a discount. VIPS was the first mover in its space in China and has established itself as a category leader, creating a distribution chain that we believe allows them to ship and deliver product more efficiently and, ultimately, faster than its competitors.
We have been impressed with VIPS’s management team, having grown revenue at a 273% CAGR between 2010 and 2013. Over the same time period, they have also taken gross margins from 9.8% to 24.0%, operating margin from -26% to 3.1%, and FCF from -$8 million to $415 million.
Cytec Industries Inc. (10% of NAV): Cytec (“CYT”) is one of the few companies approved to produce aerospace-grade carbon fiber and is one of three main suppliers for Boeing’s and the Airbus’ new composite planes like the 787 Dreamliner and the Airbus A350. Each of these planes are composed of approximately 50% carbon fiber by weight. For reference, legacy aircraft builds are comprised of only 5%–20% carbon fiber by weight. The thesis for our investment has been the shift to carbon fiber to reduce fuel costs and improve passenger comfort in new aircraft. Because of the significant backlog of airplane builds (approximately seven years), carbon fiber demand is less dependent on GDP growth. CYT is also the primary supplier for the F-35 Joint Strike Fighter, which Passport estimates could result in over $3 billion in revenue to CYT if the planned 3,000+ planes are produced. Recent technology breakthroughs and a positive outlook for the US Defense budget have put this program in a significantly better light, and production and orders are ramping significantly.
We are also constructive on the company’s earnings growth due to the demand created by new aircraft, and other products that are or are seeking to be more carbon fiber-intensive such as automobiles. The auto industry is in a rush to shed vehicle weight to comply with CO2 emission regulations, and carbon fiber can be a large part of the solution. We believe a major win in the automotive space could be announced in 2015 for a luxury car with a $200k+ price tag. Passport estimates that this class of auto would be 10x the size of the aerospace market, but still support the margins that make it attractive to CYT. The 2015 consensus EPS is approximately 5% below Passport estimates and CYT still is reflecting a multiple significantly below its peers. We believe continued execution and visibility will help close this gap.
National Commercial Bank (8% of NAV): The National Commercial Bank (“NCB”), also known as AlAhli Bank, is the first Saudi Arabian bank, the largest bank by assets in the Saudi Arabia, and one of the global pioneers in Islamic banking. At year-end, NCB had a market cap of approximately $29.3 billion. We believe NCB to be the highest-quality bank in Saudi: it generates the most net income, it is the largest by deposits and loans-issued, and it has achieved the highest in FY 2014 (20.3% vs. secondplaced Al Rajhi Bank with 17.8%). NCB’s funding costs are quite low, since approximately 75% of deposits are demand deposits and mostly Sharia-compliant, meaning they pay no interest. Saudi banks by law cannot exceed a loan-to-deposit ratio of 85%. However, NCB is only running at a loan-todeposit ratio of under 64%. We believe that these factors will allow NCB to outperform in a rising rate environment.
NCB has an annualized dividend yield of 2.4%, which compares to an average of 1.8% for the Saudi banking sector. At a 2015e PE of 11.7x, the PE of NCB is also below the 11.9x for the sector. NCB issued equity on the Tadawul (the Saudi Stock Exchange) for the first time in November of last year. Shortly after its IPO, the Tadawul announced a rebalancing of the Saudi stock index, allocating 5% to NCB—the third largest weighting in the index. As NCB is one of the most liquid, publicly traded companies on the Tadawul, we expect more sell side shops to initiate coverage, which we believe should be a near-term catalyst for the company. Moreover, with the prospect of the Saudi equity market opening to international investors in Q2 2015, we believe NCB is under-owned by global institutional investors.
Al Tayyar Travel Group (6% of NAV): Al Tayyar is a corporate travel company with a dominant market share in Saudi Arabia. It primarily provides for the government’s travel needs, including the transporting of students around the world to study abroad under the King Abdullah Foreign Scholarship Programs. Al Tayyar has an exclusive contract with the Saudi government for this program, which covers approximately 150,000 students. Additionally, it is expanding into other noncyclical business lines with high-margins like religious tourism, and it has made two acquisitions of corporate -travel companies in the U.K. and Egypt in 2014.
In FY 2014, revenue grew 23% and earnings grew 19% year over year. Other metrics have also experienced strong growth: for fiscal year 2014, Al Tayyar had an impressive ROE of approximately 44%. In addition, EBITDA has continued to grow at a remarkable clip, registering a 25% CAGR over the past five years.
Business Update
Capital Flows: As a firm, Passport had approximately $16 million in net inflows during the fourth quarter. Passport Special Opportunities had approximately $80 million in net outflows during the same period.
As always, thank you for your continued confidence and support.
Sincerely,
John Burbank III
Chief Investment Officer
Bill Nolan
Head of Sales & Marketing
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