Transitions, Macro…
The third quarter of 2024 proved to be a frustrating one for Middle Coast Investing. Our portfolios rose as a whole, but lagged both the main indices and our closer benchmarks, the Russell 2000 (one quarter after I said it was an easy benchmark to beat). Quarter to quarter noise happens, it will not be the last quarter we lag the indices, and I believe the stocks we own are worth more than their current prices, but that perspective doesn’t lessen the irritation. The issues we faced? A matter of transitions.
One of the hallmarks of both the 2020s market has been rapid transitions. The extraordinary nature of the pandemic and its after-effects has led to rapid economic distortions. Algorithmic and machine trading exacerbate these distortions in markets, treating temporary changes as permanent. That leads to disconnects between price and value, which is good for investors looking for long-term bargains. But disconnects take time to resolve.
The latest distortion is positive. The Federal Reserve has shown itself happy with the U.S. inflation outlook. With interest rates due to come down, smaller stocks and thus the Russell 2000 shot higher. Gross Domestic Product and government spending remain strong, the artificial intelligence boom/bubble has not yet burst, and so the biggest companies have also done well. Market participants are hoping for a ‘soft landing’ transition, where inflation drops without an economic recession. This happened in the 1990s, and it could happen again. Add that up and it’s not unusual that this quarter saw new all-time highs on many indices[1].
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And Micro
Why did we trail that performance? Most of the stocks in our portfolio went up, but the ones that dropped fell hard. We got few big positive earnings surprises. And beneath that are a number of individual transitions happening at these companies.
The good transitions tend to tie back to the macroeconomy. Financial companies are seen as the big winners in a soft landing. Each of our winners have good things happening with them, too. Discover (DFS) is cleaning up many of its problems from the past few years. Whether or not its deal with Capital One goes through, Discover’s business has gotten much stronger in the past six months. First Citizens National (FCNCA) is successfully integrating its purchase of Silicon Valley Bank, and set to soar if and when start-up funding grows again. F&G Annuities & Life (FG) is building out its sales muscles and benefiting from clients looking to lock in high annuity returns with rates relatively high.
Progressive Insurance (PGR) is the best example of both a macro and micro transition. Used car repair cost inflation (macro) hurt its profitability. It was early in raising prices to deal with that, and has been growing new policies in force much faster than competitors. As it has overcome the cost inflation issue, its profits have soared, and should continue to grow. The stock price has doubled in the last 14 months.
The sort of transitions we want. Photo by Suzanne D. Williams on Unsplash
Tougher Transitions
There are also not as good transitions happening. Charles Schwab (SCHW) has called 2024 a transition year as it deals with the balance sheet issues that popped up in last year’s regional bank crisis. On its last earnings call, the company suggested it may shift its fundamental model – holding client cash in a bank – given the interest rate sensitivity. This may smooth out its business, but harm its upside earnings power. The company also just announced a new CEO. I think the company’s position is safer than some in the market, and that its long-term earnings power is undamaged. But the market has been impatient so far.
Axcelis (ACLS), the semiconductor equipment maker we own in most accounts, is also in transition. Demand for electric vehicles and hybrids has slowed, while demand for memory chips has not yet picked up. Caught in between these cycles, its shares sold off heavily this quarter, and as one of our biggest positions, that hurt our results. It is also a company with a great balance sheet, that has gained share in its sector, and that is exposed to areas of our economy that should grow for years, all while priced relatively cheaply. Micron’s earnings at the end of the quarter suggested the memory recovery is at hand.
Atkore’s dilemma
Atkore (ATKR) is the most interesting case, and the most painful as our top loser for the second straight quarter. We have been waiting to see what the industrial maker of PVC pipes and metal conduits among other products will look like when things are ‘normal’. It jacked up prices during the pandemic, and those prices have declined for the last couple years. The latest earnings report made clear that management is not quite sure when the bottom hits.
On top of that, a customer sued Atkore and other PVC pipe companies, accusing them of price fixing and collusion. This echoed a short-seller argument against Atkore. The lawsuit is primarily pegged to circumstantial evidence as well as a PVC industry publication. If true, it would be a deal-breaker as far as management credibility. But it seems to be a tough case to prove, and conversely shows what a strong position Atkore has.
With infrastructure bills, data center demand, the need to harden our electrical grid, solar power demand, and more, there are positive momentum drivers for Atkore’s business. It has good position in its markets. Imagine all of its windfall pricing power goes away and the company reverts to FY 2020 net income. Adjust for Atkore’s acquisitions since, as well as its reduced share count, and you get $5.77/share earnings.
The company traded at ~14x trailing GAAP earnings before the pandemic. If I apply a penalty multiple of 12x earnings, we get $69/share. Analysts currently expect Atkore to have double those earnings in 2025. If Atkore can bottom there, the shares are probably worth above $140, with the company set to grow again. It’s painful that shares have fallen to $85 or so, and the lawsuit risk is not zero, but I think there’s a good chance Atkore will work. As long as we can ride out this transition.
The lessons from all of this? There’s no magic wand. I need to do a better job understanding company’s positions and understanding how they might shift. I’d also like to think through how to better balance individual portfolios so especially newer clients hold as many of our ‘key positions’ as possible. I often hold off on averaging up into winners unless there’s a discrete event, but for newer accounts, I am reconsidering the approach.
As for the Political Situation
There is one more pending transition to watch for: the 2024 election. I’m not going to go overlong – I have firm views, and I’m sure most people reading this do as well. This is an investing letter. I’ll only make two points.
First, one candidate for the Presidency is clearly better than the other for markets. She offers solid government funding in various areas of the economy – infrastructure, telecommunications, semiconductors – and a negative to slightly negative viewpoint towards corporations, including antitrust enforcement and a likely rise in corporate taxes. From a pure profit perspective, it would be a familiar, stable, workable policy backdrop.
The other candidate’s plans seem designed to spark inflation – shrinking the workforce via immigration / deportation policies; increasing consumer goods prices via tariffs; threatening the independence of the Federal Reserve. There is no gameplan for the economy except cutting taxes, which would further exacerbate inflation. That’s before getting into his volatile behavior’s effect on markets, most recently seen when he said Taiwan should pay us for protecting it. SMH, the semiconductor ETF, is down 10% since those statements were reported.
Secondly, while I think that Vice President Harris would be much better for the economy and stock market than President Trump in the long run, the result of the election is unlikely to affect how we invest. The election will affect some stocks and sectors, but the U.S. economy tends to grow over time and the U.S. stock market rises to reflect that. I don’t rule out the possibility of catastrophe. But I remember the market selling off and then turning around overnight in 2016, and I remember the market soaring in 2020 (admittedly, the Pfizer vaccine news helped). The market just wants to know what’s going on and what the plans are from Washington, and will then re-focus on the economy.
It matters who is president (go vote!), but we are going to be investing either way.
Our Q3 Performance
| Q3 2024 | YTD 2024 | 2023 | 2022 | 2021 | 2020 | |
| U.S. portfolios | 0.7% | 10.3% | 47.0% | -13.4% | 16.8% | 12.0% |
| Core U.S. portfolios | 0.7% | 8.1% | 47.0% | -13.4% | 16.8% | 12.0% |
| S&P 500 | 5.5% | 20.8% | 24.2% | -19.4% | 26.9% | 16.3% |
| Russell 2000 | 8.9% | 10.0% | 15.1% | -21.6% | 13.7% | 18.4% |
| S&P 600 | 9.6% | 7.9% | 13.9% | -17.4% | 25.3% | 9.6% |
| Nasdaq | 2.6% | 21.2% | 43.4% | -33.1% | 21.4% | 43.6% |
| European Portfolios | 0.6% | 12.1% | 13.4% | -15.3% | 4.5% | 18.3% |
| Euro Stoxx 50 | 2.2% | 10.6% | 20% | -11.7% | 21.0% | 3.5% |
| DAX | 6.0% | 15.4% | 19.2% | -12.3% | 15.8% | -6.3% |
Disclaimers and notes:
- See performance disclosures for more details on performance.
- These results are net of fees and include reinvested dividends or the cash received[2].
- Core portfolios exclude a portfolio with huge Amazon and Apple positions, as well as a new large portfolio (17% of total AUM) that was being managed differently. We will be including that new large portfolio in core portfolios as of Q4.
- All calculations are done by me and subject to error.
Portfolio stats
- Our portfolio level price to earnings for trailing 12 months (TTM) was 19.7. Our price to free cash flow TTM ratio was 16.9. This compares to 20.8 P/E and 17.7 P/FCF at end of Q2.
- Cash and equivalents (the ETFs MINT, JPST, SGOV, and BIL, the money market fund SNOXX, and short-term U.S. T-bills) was 17.1% of our quarter end portfolio, with an estimated average yield of 3%. This compares to 13.4% of our portfolio and 3.9% yield at the end of Q1.
- We bought 10% more equity positions than we sold in Q3.
Our top 12 positions as of September 30, 2024:
- Apple (AAPL) – 13.1% of our portfolio
- Amazon (AMZN) – 12.7%
- Progressive – 5%
- Axcelis – 4.1%
- Grupo Aeroportuario del Centro Norte (OMAB) – 3.9%
- Discover Financial – 3.6%
- F&G Annuities & Life – 2.9%
- Broadcom (AVGO) – 2.6%
- First Citizens National Bank – 2.6%
- Aercap (AER) – 2.3%
- Atkore – 2.3%
- Lululemon Athletics (LULU) – 2.3%
- Booking Holdings (BKNG) – 2%
Q3 Winners/Losers
| Winners | % Gain | Losers | % Loss |
| Apple | 1.4% | Atkore | -1.7% |
| Progressive | 1.0% | Axcelis | -1.5% |
| F&G Annuities & Life | 0.5% | Eventbrite (EB) | -0.6% |
| Discover Financial | 0.3% | Amazon | -0.5% |
| First Citizens National Bank | 0.2% | Charles Schwab | -0.2% |
| Vimeo (VMEO) | 0.2% | Gogo (GOGO) | -0.2% |
New Stocks
Apogee (APOG) – Apogee makes glass, framing systems, and aluminum or glass doors for buildings, especially commercial and office buildings. I like the company’s management. The CEO is a former 3M executive, and is focusing the company on constant margin and business improvement, and while that is easier to say than do, the company’s track record so far is successful – 500 basis points in gross margin improvement and 400 basis points in operating margin improvement from 2022-2024 (and over 200 points of each so far in fiscal year 2025), and both above pre-pandemic levels.
On top of that, Apogee is a big but regional player in a fractured market, which means it has room for growth either via acquisition – and it just announced the purchase of a coatings company – or through taking market share. It’s reasonably priced if not better, and while it is a cyclical company and won’t thrive in a recession, I think we’re paying a reasonable multiple for long-term growth.
ABM (ABM) – ABM stands for American Building Maintenance. This company is primarily a janitorial company – schools, businesses, and airports outsource their janitorial services by hiring ABM. ABM also offers parking lot maintenance, facility engineering, and provides airport services (passenger assistance, logistics, catering).
This is a boring business. Its ‘steady’ business lines have grown revenue at about 4% a year since 2019, and it’s hard to see it doing better than GDP growth. But we’re only paying 14 times earnings or so, and from our experience owning airport shares, know that this business should do well even in hard times.
The two upside kickers are a) similar to Apogee’s challenge with office buildings, ABM is struggling in its business and industry line, and if that ever goes back to normal, that could be a tailwind, and b) it is building out a microgrid and electric vehicle power station installation business. ABM’s ‘project’ business, which is less stable, has grown 9.4% a year since 2019, and while this is only 25% of the overall business, it at least has a profile that could outpace the steadier business and transform ABM’s overall business.
DMC Global (BOOM) – This is a special situation, similar to Vimeo in Q1. There is an offer on the table to buy DMC Global at $16.5/share. It looks credible, but DMC and its buyer – a billionaire – have not talked with each other.
DMC Global is an industrial business with three units – Arcadia, a building products company similar to Apogee but smaller, not as strongly performing, and west coast based; DynaEnergetics, DMC’s original business, which offers ‘perforation’ services to oil companies (meaning dynamite to blow up land for fracking and other oil drilling); and NobelClad, which sells heat-resistant metals to a variety of businesses.
This is not the sort of business I’d normally own. But the offer is credible, and BOOM was already undergoing a strategic review, which can mean a sales process. There are some other weird notes around management here. The stock isn’t terrible to own at its 52-week low of $10.5 (we bought shares at $13). Our worst case is if DMC sells off its oil-oriented businesses at a low price to focus on Arcadia, and that’s what I’m watching out for.
Dividend Stocks
As mentioned above, we’ve taken over management of a large new portfolio. It is half bonds and half stocks. While I am selling most of the stocks that were in there, I have bought more of some of the good companies with reasonable valuations: JP Morgan (JPM), Hershey’s (HSY), and Traveler’s Insurance (TRV), specifically.
Other stocks added
We added meaningfully to our OMAB (Central North Airport Group in Mexico) position. A year ago, shares of this and PAC (Pacific Airport Group) plunged on government regulation concerns, but also a hurricane hitting Acapulco (OMAB runs the airport) and plane engine issues for the major Mexican airline, Volaris.
We start to lap those issues in October and November, meaning comparisons get easier for the business. Mexico also has a new president, Claudia Sheinbaum. She is from the same political party, and that party has a supermajority and is ramming through a controversial judicial reform. But I expect her to be less contentious and more technocratic than her predecessor, Andreas Manuel Lopez Obrador (AMLO)[3]. And PAC recently announced (PDF) its new Master Development Plan approved by the government, and while it calls for a lot of investment, it also has healthy tariff increases built in. I don’t think the government is “coming” for the airport businesses, and the share prices are more than reasonable.
I added Dallas News (DALN) in a client account for the first time. The newspaper business posted a legitimate, no special benefits profit in Q2. It has appeared to cut costs to the point where it can make money, it actually grew revenue in Q2 when accounting for discontinued products or programs, and it is selling a building/real estate lot that could reap meaningful returns for shareholders. “Newspaper business in 2024” does not sound like a good investment, but the NY Times have done well and DALN’s chances of getting a small-scale turnaround right are improving.
Astronics (ATRO) had one of the better earnings reports in our portfolio but reported on the same day as a huge market sell-off, and shares still dropped. It is raising revenue guidance and producing well in its test segment. The one new question is how long the Boeing strike goes on and how much this dampens Astronics’ short-term prospects. Longer-term, we need more planes, which is good for ATRO shares. We added.
In personal accounts I made a pair trade, i.e. buying shares of one company and selling shares short of a related company, in Portillo’s (PTLO) (long) and Kura Sushi (KRUS) (short). Both are restaurant chains who have come to the markets in the last few years; Portillo’s is reasonably valued to its prospects, Kura Sushi quite expensively valued. Restaurants are tough, and I wasn’t convinced about Portillo’s, so I closed this trade with a gain on both sides. I later re-shorted Kura Sushi without pairing it with Portillo’s, and am overall down marginally at the end of the quarter.
We added to our stakes in Lululemon, Discover Financial, Archer-Daniels-Midland (ADM), and Axcelis.
Other stocks sold
A last transitioning company that I gave up on and sold out of is EventBrite. The company has been switching to a ‘marketplace’ model, where it charges event hosts more in return for, in theory, generating more business for them. EventBrite lowered guidance pretty drastically in Q2, and underlying that is that EventBrite’s product/ecosystem isn’t strong enough to keep customers at higher costs. I missed this, thinking because it was the biggest in its space it would be the best. Eventbrite has proven replaceable.
We sold GOGO shares more quickly. The Q2 earnings report included more delays for the company’s 5G and lower earth orbit airline wifi products, and at some point owning shares becomes a leap of faith in management. On the last day of the quarter, the company announced a major acquisition which seems like a distraction. I’m still watching the stock, but am relieved we got out at a small loss.
We also sold our McDonald’s (MCD) position as well as several stocks from the dividend portfolio; we trimmed our stakes in Apple, Vimeo, FG, and Booking Holdings, and net trimmed our Atkore stake due to client cash needs.
Interested in more from Middle Coast Investing? Or in talking to us? Get in touch.
Please read our full performance disclosures.
Disclosure: I am long or short all positions as mentioned in this letter. I may change positions at any time. I have no immediate plans to make major changes. This is not investment advice. Investing is risky. Any investing decisions are your own responsibility and should be taken after speaking with an advisor or at your own risk. This is not a solicitation to buy or sell anything. Past performance is of course no promise of future results.
Disclaimer: I calculate performance and all portfolio figures manually, so it may be prone to error. The accounts I manage may deposit or withdraw money over the course of a quarter. I account for that in my calculations by adding/subtracting that money to/from the starting amount at the beginning of the period. This means withdrawals intensify performance and deposits dampen it. For half-year, 9-month, and full-year performance, I multiply quarterly performance by one another to control for deposits/withdrawals.
[1] All-time records should not be all that rare; over the long haul, stocks go up as earnings go up, and so they are likely to set new records. How much the stocks worth is more important to follow.
[2]Schwab does not allow dividend reinvesting for foreign stocks.
[3] Loosely, imagine if Elizabeth Warren were succeeding Bernie Sanders as President.