Monthly Archives: October 2014

Portfolio Construction Thoughts 10/28/2014

Portfolio Construction Thoughts 10/28/2014

We are very selective in the opportunities we recommend illustrated by the current portfolio holding only two positions and over 80% in cash. We adhere to the philosophy of waiting for “fat pitches” (odds heavily skewed in our favor) and loading up on these opportunities when they present themselves as these opportunities are rare. There are two key assumptions driving our portfolio construction views.

First, permanent loss of capital is the biggest risk of any investment therefore the riskier the expected return/cash flows from an investment, the smaller the weight.

Second, valuation is the key driver of returns therefore the cheaper the opportunity the larger the weight.

We look for high quality companies with a sustainable competitive advantage, strong growth outlook, and good management trading at a discount to intrinsic value. High quality companies are entered into the portfolio at a 5% position if the expected annual return is 15%. Position size is increased as the expected return increases with a potential of up to 15% if the expected return is large enough.

We also look for companies that may not be as high quality but have a strong growth outlook, quality management trading at a significant discount to intrinsic value. These companies are typically near the top of the industry in terms of profitability. These investments require an expected annual return greater than 20%, and start at a 5% position size that can increase to 15%.   PC Jeweller is a perfect example of this type of investment. PC Jeweller is a company that operates in a highly competitive industry where there are no barriers to entry (illustrated by the thousands of competitors), demand is cyclical and there are high fixed costs of operation (rent & salaries). PC Jeweller is one of the best operators in the industry (efficiency/profitability) and the industry is only at the beginning of its life cycle so there is plenty of room for growth easing competitive pressures. At the time of investment, PC Jeweller’s expected annual return was 23% before factoring in any growth so close to 30% assuming a sustainable growth rate. PC Jeweller’s extremely attractive yield, a clear path to doubling its store count and weaker competitors trading at premium valuations, PC Jeweller’s initial position size was 12.5%.

We also look for special situations. The position size of these investments is 5%.

The minimum position size is 5% allowing potential investments to make a meaningful contribution to performance. This is also a function of the depth of our research and the high threshold for inclusion. With a five year investment horizon, 20% of the portfolio is turned over annually. With each position at a 5% position size, four new positions are required per year, which is in-line with our target for one idea per quarter.

We believe the benefits of diversification are overstated evidenced by the best investors tend to be concentrated and focused. Diversification is good strategy for scenarios where the odds are slightly skewed in your favor. When the average investor is turning over his/her portfolio over 100% per year diversification is a requirement as the outcome of the short term holding period is driven by momentum and noise rather than fundamentals. Given we wait for the odds to be heavily skewed in our favor, we get to know our investments and we hold assets for the long term to allow fundamentals to be the driver of the share price, diversification is not significant.

PC Jeweller Position Size Update 10/27/2014

PC Jeweller Position Size Update 10/27/2014


PC Jeweller’s share price appreciated and the company is trading on an EBIT yield of 15%. We are happy to own a growing asset yielding 15% before accounting for growth, especially when investment requirements are minimal. Financial statements point to inventory being a burden but inventory is financed through gold leases where there is no price risk if the gold is sold within 180 days  and no upfront investment creating minimal price risk of holding inventory. With that stated, further share price appreciation is dependent on improvements in the business, or assumptions of elevated margins as valuations are no longer extremely cheap. While both assumptions should come to fruition, the lack of extreme undervaluation leads us to decrease our position in PC Jeweller from the current 13.14% to 7.5%, assuming the market does not open down drastically tomorrow.

Q3 2014 Reperio Capital Model Portfolio Performance

Q3 2014 Reperio Capital Model Portfolio Performance

In Q3 2014, only two positions met our strict criteria for recommendation and portfolio inclusion. PC Jeweller and Zensar Technologies were recommended and initial position sizes of 12.293% and 4.105%, respectively, were built. The remainder of the portfolio is allocated to cash until additional investment opportunities meeting our strict criteria are identified.

Despite a starting and ending cash position above 80%, our model portfolio appreciated by 12.97% USD return in the third quarter of 2014 equating to an 16.88% excess return relative to the iShares MSCI Emerging Market Index (EEM) and 14.05% excess return relative to the iShares MSCI Emerging Market Small Cap Index (EEMS).  Both positions performed well with the equity portion of the portfolio appreciating by 69.21% in the quarter.

Q3 2014 Model Portfolio Performance

PC Jeweller’s share price appreciated by 91.8% in rupee terms. The strength of PC Jeweller’s performance lead to a sale of roughly 40% of the position at a weighted average price of ₹247.86 representing a 109% gain on sold shares. After the sale, PC Jeweller’s ending position size was 12.7%. PC Jeweller is still undervalued on an EV/Owner’s Earnings of 8.52. The company had weak quarterly numbers, touched on here, but should double its showroom count over the next 5 years with high probability of further margin (higher diamond sales) and multiple expansion (peers trade at an unjustified premium to PC Jeweller).

 PC Jeweller Target Price Assumptions

On September 30, 2014, PC Jeweller announced a partnership with Flipkart to create a platform for online jewelry shopping. PC Jeweller’s hope it to create a seamless online-offline shopping experience where purchases can be made online and returned at anyone of PC Jeweller’s 46 showrooms. Flipkart is a leading ecommerce site and one of the ten most visited sites in India. It reached USD 1 billion in sales in 2014, a year ahead of the company’s target. This partnership illustrates PC Jeweller’s management strength and gives the company a huge opportunity to create a leading Omni-channel presence.

Zensar’s share price appreciated by 40.7% in rupee terms leading to an ending position size of 5.0% position. In the quarter, among other things, Zensar reported weak margins in its latest quarterly report, acquired a company and announced a partnership. The quarter’s earnings were already discussed in an earlier post. Zensar first entered into a definitive agreement to acquire Professional Access. Professional Access is one of the largest Oracle ATG and Endeca partner in the world with USD38 million in revenues. It strengthens Zensar’s e-commerce solutions. It is a key strategic area and a good acquisition. Zensar also announced a partnership with Agile Financial Technologies. This greatly strengthens Zensar’s financial vertical business as well as strengthens its presence in Middle East.

Zensar should continue to grow revenues at a low to mid-teens rate for the near future, yet the company is trading at a no growth valuation. If management is able to reach its revenue and margin targets over the next two to three years, the company’s intrinsic value is more than double the current share price. The company would have a higher position in the portfolio but liquidity is an issue.

 Zensar Target Price Sensitivity Table 9222014