Black Bear Value Partners Q3 2024 Letter
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“Habit is a cable; we weave a thread of it each day, and at last, we cannot break it.” – Horace Mann
To My Partners and Friends:
Black Bear Value Fund, LP (the “Fund”) returned +0.9% in September and +5.5% YTD. The S&P 500 (SP500, SPX) returned +2.1% in September and +22.1% YTD. The HFRI Index returned +1.1% in September and +9.4% YTD. We do not seek to mimic the returns of the S&P 500 and there will be variances in our performance.
Note: Additional historical performance can be found on our tear-sheet. |
Habituation is the process of becoming accustomed to something, after frequent exposure to repeated stimulus, resulting in a diminished physiological or emotional response. A benign example would be living in a busy city and eventually not noticing the loud noises coming from the outside. Another example could be the psychology of many investors who have become habituated to 1-2% interest rates and an expectation that this normality will return. I am skeptical.
Money was close to free for the decade-plus after the Great Financial Crisis. This resulted in various manias and bizarre (though explainable) investor phenomenon (MEME stocks, SPAC’s etc.) More persistent are the capital structures of both public and private companies that gorged on cheap debt and are fast approaching judgement day when the debt will need to be repaid. Hope is not a strategy yet the habituated belief of 2% interest rates being normal pervades a lot of thinking and analysis Rates are higher now and likely to remain so. We are still in the early stages of this transition, and it is too soon to tell the long-term impacts of such loose financial conditions. I am circumspect that it will go as smoothly as some predict and maintain a more conservative portfolio with a large amount of asymmetric hedges/shorts.
Interest Rates/ Credit Shorts/ Equity Shorts
We materially increased our credit shorts and now include Junk bonds again. We continue to be short long-term interest rate/credit instruments. The 10y rate dropped below 4% in the 3rd Quarter and credit spreads are at all-time tights.
Option volatility has gone back to pre-2020 levels. I switched our short back into options which gives us a very asymmetric profile if long rates and/or spreads widen out. This was a big beneficiary to the partnership in past years and protected our capital in 2022.
Taking a step back if we were to presume
- 2-2.5% inflation is achieved then….
- Short-term interest rates would likely be in the ~2.5-3% range which would mean….
- A normal 10Y treasury would be in the 4-4.5% range, compared to 3.8% at quarter-end.
There is general confusion as to what kind of rate-setting power the Federal Reserve has. The Fed sets short-term interest rates (aka the Fed Funds rate). Absent market intervention, the market (i.e. supply & demand) will dictate what the longer-term interest rates will be. As you can see above, the current 10Y interest rate presumes success in getting inflation down to the low-mid 2’s. Interest rates would be higher if:
- Inflation (real or forecasted) was persistently higher than 2-2.5%
- There was a need to fund increased fiscal spending/deficits – seems likely
- We needed to rollover existing low-rate debt – historical supply is coming
- A host of other variables that could go on ad infinitum
Many companies are entering a period with a need to refinance historically cheap debt. Spreads reflect close to ZERO concern about corporate balance sheets and the impact of lower margins and increased funding costs.
There is a potential for rockiness in both credit instruments and companies dependent on cheap borrowing. We are short the Companies as well.
Top 5 Businesses We Own
ARCH Resources (ARCH) / CONSOL Energy (CEIX)/ Warrior Met Coal (HCC)
ARCH and Warrior are 2 of the leading U.S. producers of high-quality metallurgical coal (“met coal”). This is the kind of coal used for steelmaking. ARCH also has a small thermal coal business that contributes ~20% of their earnings. CONSOL is a leading producer of thermal coal. During the 3 rd quarter ARCH and CONSOL announced a merger which should close in the first half of 2025. I am generally constructive on the merger as the Companies should be able to realize some modest synergies. My sense is more mergers will be coming to this sector given the depressed prices of the securities.
Met coal demand is projected to climb for the next 25 years, driven by the economic development and urbanization in India and the rest of Southeast Asia. ~60% of the world’s population lives in Asia, where met coal demand is centered and where local sources are limited. Over the coming years demand will likely outstrip supply, leading to higher prices. There has been a severe lack of investment in met coal due to ESG concerns with investment peaking in 2014.
I would like to point out to you our Q1 letter which discusses CEIX and our Q2 letter which discusses how we value ARCH.
Builders FirstSource (BLDR)
BLDR is a manufacturer and supplier of building materials with a focus on residential construction. Historically this business was cyclical with minimal pricing power as the primary products sold were lumber and other non-value-add housing materials. Since the GFC, BLDR has focused on growing their value-add business that is now 50%+ of the topline. The company has modest leverage and has been using their abundant free-cash-flow to buy in over 41% of the stock in the last ~3 years.
While mortgage rates are higher, they are not unusual versus history. The low rates of the last 5-10 years are the outlier. We have a structural shortage of housing in the USA. With existing homeowners locked into low-rate mortgages, the aspiring homeowner may increasingly need to find a home from a homebuilder.
Normalized free cash flow per share looks to be in the range of $13-$16 per year. Margins are structurally higher given their increased shift into value-add products. At quarter end pricing of ~$194 that implies a free- cash-flow yield of 7-8% which does not reflect the long-term housing needs or their pricing power.
Paramount is an ENP (exploration and production) in the energy space. It has net cash and securities of $630MM (20% of the mkt cap). Management is fully aligned with us as they own 46% of the Company. 2024 FCF will likely be ~3% yield which at its face doesn’t scream cheap. Management is reinvesting in near-term attractive growth opportunities. Absent this reinvestment, Paramount would generate a 12-14% unlevered free cash flow yield. This is a business that should benefit if there is overall weakness in the energy sector as they have an abundance of cash/securities on hand and cash-generating assets.
Volatility
Day to day volatility has increased dramatically since May. Given the upcoming election I am prepared for that to continue. Geopolitical risks are under-appreciated and the habituation of investors to permanent sunny skies has led to complacency again. We will remain patient and continue to act decisively and take advantage of the short-termism that seems to be more present every day. Our businesses have the ability and track record of taking advantage of rocky markets. We stand to benefit.
The Habituation of Antisemitism
I’ve been warned that expressing my views within an investor letter is too personal and have lost potential investors because of my vocal stance in the past. I can live with that. I have a small platform, and it would be misused if only for investment ideas.
Yesterday was the 1-year anniversary of 10/7 and several people reached out to ask how I was doing. It’s hard to describe the mixture of emotions which often run into conflict with each other. I will take some liberty in assuming many others feel similar. I am anxious and concerned about the habituation and normalization of antisemitism across our great country. I am enraged that so many chaos agents are running amok in our society while many sit by silent. I am proud of our history and our perseverance. I am appreciative of those who have shown their friendship during a difficult year and hopeful that better days lie in front of us.
We are being habituated into a new normal… heavily armed guards protecting us on our way in and out of our synagogue or school? Jewish friends or acquaintances being attacked by mobs of people while onlookers watch and film? My former intern and others college students who must keep their heads on a swivel for fear of being attacked or blocked on their way to class? I could go on…. This is madness and totally unacceptable.
If we are not careful, we will let these chaos agents, who do not value life or freedom, dominate the narrative and ultimately hurt our wonderful country and world. Some of the world’s worst atrocities occurred because, over time, populations became habituated to unacceptable and dangerous behavior and rhetoric, while the situation devolves. It’s imperative to use your platform and speak up, to be proud, principled and strong. If we stay silent and do not bring a voice to completely unacceptable behaviors, we become part of the problem. I know we can do better so try to do your part. Sometimes leadership is the willingness to be uncomfortable so join us in our discomfort.
We pray for peace and for the safe return of the hostages who are now in their second year of captivity. You are not forgotten.
Thank you for your trust and support.
Adam Schwartz
Black Bear Value Partners
THIS DOCUMENT IS NOT AN OFFER OF, OR THE SOLICITATION OF AN OFFER TO BUY, INTERESTS IN BLACK BEAR VALUE PARTNERS, LP (THE “FUND”). AN OFFERING OF INTERESTS WILL BE MADE ONLY BY MEANS OF THE FUND’S CONFIDENTIAL PRIVATE OFFERING MEMORANDUM (THE “MEMORANDUM”) AND ONLY TO SOPHISTICATED INVESTORS IN JURISDICTIONS WHERE PERMITTED BY LAW. This document is confidential and for sole use of the recipient. It is intended for informational purposes only and should be used only by sophisticated investors who are knowledgeable of the risks involved. No portion of this material may be reproduced, copied, distributed, modified or made available to others without the express written consent of Black Bear Value Partners, LP (“Black Bear”). This material is not meant as a general guide to investing, or as a source of any specific investment recommendation, and makes no implied or express recommendations concerning the matter in which any accounts should or would be handled. The returns listed in this letter reflect the unaudited and estimated returns for the Fund for the periods stated herein and are net of fees and expenses, unless stated otherwise. Black Bear currently pays certain fund expenses, but may, at any time, in its sole discretion, charge such expenses to the Fund. Please note that net returns presented reflect the returns of the Fund assuming an investor “since inception,” with no subsequent capital contributions or withdrawals. You should understand that these returns are not necessarily reflective of your net returns in the Fund, and you should follow-up with Black Bear if you have any questions about the returns presented herein. An investment in the Fund is speculative and involves a high degree of risk. Black Bear is a newly formed entity with limited operating history and employs certain trading techniques, such as short selling and the use of leverage, which may increase the risk of investment loss. As a result, the Fund’s performance may be volatile, and an investor could lose all or a substantial amount of his or her investment. There can be no assurances that the Fund will have a return on invested capital similar to the returns of other accounts managed by Adam Schwartz due to differences in investment policies, economic conditions, regulatory climate, portfolio size, leverage and expenses. Past performance is not a guarantee of, and is not necessarily indicative of, future results. The Fund’s investment program involves substantial risk, including the loss of principal, and no assurance can be given that the Fund’s investment objectives will be achieved. The Fund will also have substantial limitations on investors’ ability to withdraw or transfer their interests therein, and no secondary market for the Fund’s interests exists or is expected to develop. Finally, the Fund’s fees and expenses may offset trading profits. All of these risks, and other important risks, are described in detail in the Fund’s Memorandum. Prospective investors are strongly urged to review the Memorandum carefully and consult with their own financial, legal and tax advisers before investing. The development of an investment strategy, portfolio construction guidelines and risk management techniques for the Fund is an ongoing process. The strategies, techniques and methods described herein will therefore be modified by Black Bear from time to time and over time. Nothing in this presentation shall in any way be deemed to limit the strategies, techniques, methods or processes which Black Bear may adopt for the Fund, the factors that Black Bear may take into account in analyzing investments for the Fund or the securities in which the Fund may invest. Depending on conditions and trends in securities markets and the economy generally, Black Bear may pursue other objectives, or employ other strategies, techniques, methods or processes and/or invest in different types of securities, in each case, that it considers appropriate and in the best interest of the Fund without notice to, or the consent of, investors. Performance returns compared against benchmark indices are provided to allow for certain comparisons of Black Bear’s performance to that of well-known and widely-recognized indices. Such information is included to show the general trend in the markets during the periods indicated and is not intended to imply that the holdings of any of the applicable accounts were similar to an index, either in composition or risk profile. The indices represented herein are the S&P 500 and the HFRI EH: Fundamental Value Index (“HFRI EH FVI”). The S&P 500 is a free-float weighted/capitalization-weighted stock market equity index maintained by S&P Dow Jones Indices, which tracks the performance of 500 large companies listed on U.S. stock exchanges. The HFRI EH FVI reflects fundamental value strategies which employ investment processes designed to identify attractive opportunities in securities of companies which trade a valuation metrics by which the manager determines them to be inexpensive and undervalued when compared with relevant benchmarks. This presentation contains certain forward looking statements. Such statements are subject to a number of assumptions, risks and uncertainties which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward-looking statements and projections. Prospective investors are cautioned not to invest based on these forward-looking statements. 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