Lockstep Value Fund – Updates & insights
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Performance month to date
The Value Fund has had a solid month thus far, up 2.1% month-to-date. The fund was launched back in February 2022, probably the worst time to launch (from a marketing point of view), and is down 6.0% since inception.
At the beginning of the month, we launched our Premium Fund to the public. The Premium Fund follows the same long-term, value investment philosophy as the Value Fund, however, is a more concentrated portfolio of our highest conviction investments. It is up 6.5% month-to-date but down 3.7% since its inception in February 2022.
Performance vs the market
Both the S&P and Nasdaq continue to recover with the S&P 500 and the Nasdaq Composite up 2.4% and 2.5% respectively month-to-date. It has been a busy earnings season for the market. Earnings have come in mixed with some sectors performing better than expected, while others are showing visible signs of slowing down, for example, the semiconductor industry, as earnings start to normalise post the surge in demand during global lockdowns. Certain macro indicators have also come in positive such as July's inflation down slightly from June. While the S&P 500 and Nasdaq composite have had a strong month and a half recovery, they remain down 11.3% and 18.8% respectively, year-to-date.
The big debate among the market experts is whether the worst is over or if this is just a short-term rally before the selling continues. You will hear us say over again that we are not macro investors, we do not try to predict the direction of the market or time it and therefore do not have a strong view of where it is heading. From a pure valuation point of view, many companies are overvalued. These businesses are valued at absurd multiples of revenue yet have never made a profit while being overleveraged in a rising interest rate environment. We find it hard to believe the worst is over while the market is crowded with such valuations. Regardless we are not overly concerned.
As long-term investors, we use market weakness as an opportunity to invest. Though we might have picked the worst time to launch a fund from a marketing perspective, we are thrilled with the opportunities that have presented themselves over the last 6 months.
Drivers of our performance
The positive performance this month is being driven by three of our largest holdings in the Value Fund, our real estate company, our apparel retailer, and our manufactured housing investment, Legacy Housing Corporation.
Legacy Housing Case Study
Legacy Housing Corp. (LEGH) is the 4th largest producer of manufactured housing in the United States. The company has been in operation since 2005 and has 3 manufacturing facilities, two in Texas and one in Georgia, both areas with high housing demand. The company was listed on the Nasdaq exchange in December 2018, but it is unlikely you have heard of it as its market valuation is less than $500 million.
Although the company has gone from strength to strength since listing, 2022 has been a difficult year for LEGH as there have been numerous concerns with the business of late;
• The CFO unexpectedly resigned at the beginning of the year.
• In March the board announced it was conducting an internal review of its inventory management which prevented it from filing its December 2021 Full-Year financial statements and its March 2022 first-quarter (Q1) results.
• Then in June, the CEO stepped down.
All of the above are red flags, and the fact that the company changed auditors in 2021, definitely didn't help alleviate shareholder concerns. It is also important to remember that the market during this time was in a panic that the US was about to enter another housing crisis and real estate stocks across the board were being sold. With all these issues plaguing LEGH, we were not surprised to see its share price more than halve over a short period.
Being familiar with the company, and the quality of the management, who happen to be the largest shareholders, we didn't take the negative news at face value. We, therefore, started to dig deeper, and our research led us to believe the company's issues were minor and that the market was overly pessimistic about the industry outlook. LEGH is uniquely positioned, thanks to its geographical location, in an industry that has been thriving due to pent-up demand, furthermore, the business does better in a rising interest rate environment as its target market is forced to trade down to manufactured homes due to unaffordable bond prices at higher price points. Analysis of LEGH's peers, who continued to report earnings while LEGH couldn't, concurred that the industry is thriving. Post our research and several conversations with the new CEO, we used share price weakness to substantially increase our holding in LEGH for both the Value Fund and Premium Fund.
At the beginning of this month, the company released its long overdue 10-K (Full-year financial statements) revealing the internal weaknesses were indeed minor, resulting in no material impact on the company's ability to operate or profitability. On the 17th of August, the company announced it will release its Q1 and Q2 10-Q (quarterly financial statements) in mid-September while at the same time provided the market with its 6-Month (6M) earnings projections with 6M 2022 revenue and operating income expected to be 35% and 40% higher than 6M 2021 respectively. The share price is up over 30% month-to-date because of the positive news.
While we continue to believe the company is still materially undervalued at the current share price, we caution anyone from going out and buying the shares before doing their own homework first.
Closing Thoughts
We are proud of our performance over the last month and a half as our hard work is starting to bear fruit. We still see significant upside in the Value Fund, so much so that we added a significant portion of our own money into the fund at the beginning of the month. At a weighted valuation of 7.6x operating income, we are excited about the potential, especially considering the quality of companies sitting in the portfolio.
Our returns are not going to be in a straight line, as the market is especially manic (when is it not!), reacting to any slight change in the economic narrative. We are not concerned however as we are in this for the long term. Our job is to seek out high-quality businesses, stick to our principles and invest only when we find something truly worth owning. It takes time, it takes experience, but most of all it takes discipline and patience.
We know you are busy following your passions. Investing is ours, so let us do the hard work for you.
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