Insider Monkey has seen a copy of Ascend Capital’s 2014 Q3 investor letter. Malcolm Fairbairn founded Ascend Capital in 1999. Ascend Partners Fund I returned a cumulative 305% between January 1, 2000 and September 30, 2014. This translates into an annualized return of about 10%, vs. around 4% for the S&P 500 Index during the same period. Ascend Partners Fund II, which was launched in 2004 underperformed the S&P 500 Index by 17 percentage points. The fund’s annualized return is about 6.9% vs. 7.7% for the S&P 500 Index. We should note that Ascend Partners’ funds exhibited much lower volatility and minimal declines during 2008, so their risk adjusted returns are potentially much more attractive than investing in an index fund.
In this article we will share Malcolm Fairbairn’s discussion of the energy sector (this is as of October 10th) and discuss whether his comments were on target or not:
“Lower crude prices are a good thing until they aren’t, since crude usually trades on pure supply and demand. The market has feared oversupply for 12 months and priced that fear into the oil price. Weakening demand numbers from China, Europe and mixed US indicators were not in the crude price and are now driving crude prices down.
Energy was the worst performing S&P sector in 3Q, it was down over 9%. Most of this underperformance came in September, when off shore drillers, for example, were down a stunning 21%.
At $90 WTI North American E&P cashflows will still go up high single digits, but we don’t know if $90 is the bottom in the oil price (as of Oct 10th it is not), and it is difficult to find a valuation bottom in service stocks given this lack of long term asset valuation and dividend support. We are closing out our positive stand towards onshore US pressure pumping even though 3Q earnings calls should reveal a tight market with an inflection upwards in pricing. We have renewed conviction that the upcoming months will see capitulation by all involved with offshore drillers as more “good” 5th gen floaters go idle, the number of working floaters remains resolutely flat, and newbuild deliveries continue. In this scenario, Transocean has downside from $32 today to $25. Valuations get downright scary if you impair the fleets at DO and RIG (a necessary condition to balance the market) and look at earnings power in the next upcycle. We also see deterioration in jackup fundamentals accelerating as the wave of jackup newbuilds starts to hit.
In today’s decidedly “risk off ” energy market, we remain long on refiners such as TSO and PSX, which are increasing cashflows through aggressive internal projects and have less earnings exposure to the volatile WTI/Brent spread. The short term outlook for TSO is especially strong given strong product cracks due to a number of unplanned outages. The long term positive outlook for US West coast refiners remains unchanged: (1) USWC refinery profits can improve as Bakken barrels displace ANS and foreign barrels (2) growing gasoline demand in the protected California market as vehicle miles travelled growth trumps fuel efficiency gains. September saw the first shipment of ANS crude to South Korea in over a decade – a sign of the longer term thesis playing out. And additionaly the EPA revised their 2014 mpg estimates down.
Ethanol stocks took a beating as the crush margin collapsed with the gasoline price, DDG prices collapsed after China banned DDG imports (nominally to protect Chinese cattle from a GMO strain of corn, but we see this as simple protectionism, as the Chinese corn crop is the largest on record), inventories remain high, and we saw the full ethanol fleet running in 3Q. Given corn prices near margin production costs, we don’t see ethanol margins recovering until crude recovers.
We are no longer short natural gas, as winter fears likely drive prices higher. We do remain short Marcellus/Utica producers, as we see too little pipeline capacity for 2015. We do not think winter can save the Marcellus. Even if the met group at Citi is right, and we see a winter that is 6% colder than average, that implies a 1.7bcf/d demand DECREASE from last winter. Add in the 3 bcf/d of production growth in the Marcellus, and we see little hope.”
Overall Malcolm Fairbairn’s comments were accurate. He predicted Transocean going down about 25% to $25 per share. The stock declined almost 50% and currently trades at $17.90. He was bullish on Phillips 66 (PSX), which declined 10% since October 10th, and Tesoro Corporation (TSO), which returned 20%. His long energy picks delivered an average gain of 5% during a brutal period of declines in oil prices.
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