Locust Wood Capital Management’s Top Stock Picks for 2016

Stephen J. Errico founded New York-based long/short equity hedge fund Locust Wood Capital Advisers in 2002, after spending 20 years working at several prominent financial firms including Lehman Brothers, Inc., Paine Webber Inc. and Morgan Stanley Inc. Since its inception the fund has grown from $29 million in assets under management (AUM) to $940 million in AUM, as of September 30, 2015. For its investments, the firm primarily looks for companies that are undergoing significant corporate transformations and then analyzes whether those transformations are being properly priced by the market. Within investing circles, Locust Wood Capital Advisers is known for exhibiting high quarterly turnover. However, a look at the fund’s latest 13F filing submitted with the Securities and Exchange Commission (SEC) for the reporting period ending December 31 demonstrates that the fund bucked that trend in the fourth quarter. According to the filing, the fund’s portfolio had a relatively low turnover of 21.05% during the October-to-December period. That low turnover was achieved in part by initiating a stake in only five companies while selling off its  stake in only three companies. In this article, we are going to take a closer look at the fund’s top five equity holdings going into 2016.

We track prominent investors and hedge funds because our research has shown that historically their stock picks delivered superior risk-adjusted returns. This is especially true in the small-cap space. The 15 most popular small-cap stocks among a select group of investors delivered a monthly alpha of 80 basis points between 1999 and 2012. This means investors would have generated 10 percentage points of alpha per year simply by imitating hedge funds’ top 15 small-cap ideas (see the details here).

#5 JPMorgan Chase & Co. (NYSE:JPM)

Shares Owned by Locust Wood Capital Advisers (as of December 31): 539,236

Value of Holding (as of December 31): $35.6 Million

Let’s start with JPMorgan Chase & Co. (NYSE:JPM), of which Locust Wood sold 2,896 shares during the fourth quarter. Nonetheless, JPMorgan Chase & Co. (NYSE:JPM) climbed a spot to become the fund’s fifth-largest holding at the end of 2015. Shares of the banking giant have lost over 14% year-to-date despite the better-than-expected numbers it reported for the fourth quarter on January 14. While analysts were expecting the bank to report EPS of $1.25 on revenue of $22.89 billion, it reported EPS of $1.32 on revenue of $23.70 billion. On February 8, analysts at Deutsche Bank reiterated their ‘Buy’ rating and $70 price target on the stock. Billionaire Ken Fisher‘s Fisher Asset Management increased its stake in JPMorgan Chase & Co. by 1% to nearly 14 million shares during the fourth quarter.

#4 Liberty Interactive Group (NASDAQ:QVCA)

Shares Owned by Locust Wood Capital Advisers (as of December 31): 1.4 million

Value of Holding (as of December 31): $38.31 Million

Though shares of Liberty Interactive Group (NASDAQ:QVCA) remained nearly flat during the fourth quarter, the 195,157 shares of the company that Locust Wood Capital Advisers acquired during the fourth quarter pushed the position up three spots quarter-over-quarter to become the fourth-largest holding of the firm at the end of December. After making their lifetime high of $31.62 in August of last year, shares of Liberty Interactive Group (NASDAQ:QVCA) have steadily drifted lower and currently trade down by over 15% this year alone. The company is expected to report its fourth quarter numbers on February 26 and analysts project it to report EPS of $0.48 on revenue of $3.25 billion. For the same quarter of 2014 the company reported EPS of $0.57 on revenue of $3.25 billion. On December 8, analysts at Pacific Crest initiated coverage on the stock with an ‘Overweight’ rating and $31 price target, which suggests upside potential of about 20%. Billionaire Mario Gabelli‘s GAMCO Investors reduced its stake in Liberty Interactive Group by 7,724 shares during the October-to-December period, to 1.94 million shares.

#3 Allergan plc Ordinary Shares (NYSE:AGN)

Shares Owned by Locust Wood Capital Advisers (as of December 31): 142,337

Value of Holding (as of December 31): $44.48 Million

Locust Wood Capital Advisers reduced its stake in Allergan plc Ordinary Shares (NYSE:AGN) by 1% in a quarter that saw pharma giant Pfizer Inc. (NYSE:PFE) make a $160 billion bid for the company. Shares of Allergan plc Ordinary Shares (NYSE:AGN) saw a major rally shortly afterwards in anticipation of this deal, but have given most of the gains back this year as they trade down by 15% year-to-date. On February 8, RBC Capital Markets analyst Randall Stanicky released a note in which he reiterated his ‘Outperform’ rating and $354 price target on Allergan’s stock. In his note, Stanicky mentioned that he expects the Allergan-Pfizer merger to be completed in the second-half of 2016 and that it is unlikely that the deal will fail. Phill Gross and Robert Atchinson‘s Adage Capital Management reduced its stake in Allergan by 70,300 shares during the fourth quarter, to just under 570,000 shares.

#2 McDonald’s Corporation (NYSE:MCD)

Shares Owned by Locust Wood Capital Advisers (as of December 31): 412,916

Value of Holding (as of December 31): $48.78 Million

It seems the more than 20% rally that McDonald’s Corporation (NYSE:MCD)’s stock witnessed during the fourth quarter enticed Locust Wood to take some profits off the table, as the fund reduced its stake in the company by 11% during that period. Unlike most other large-cap stocks, McDonald’s Corporation (NYSE:MCD)’s shares saw a decent rise in January of this year, after the company reported its best quarterly numbers in four years. Even though they have given up most of those gains this month, shares are still trading nearly flat for the year, greatly outperforming the market. For the fourth quarter, the company reported EPS of $1.31 on revenue of $6.34 billion both of which topped analysts’ expectations of EPS of $1.23 on revenue of $6.22 billion. The all-day breakfast service that the company recently launched was cited as one of the key drivers for its growth in the quarter, which led to a 5.7% jump in U.S comparable-store sales.

#1 Liberty Ventures (NASDAQ:LVNTA)

Shares Owned by Locust Wood Capital Advisers (as of December 31): 2.14 million

Value of Holding (as of December 31): $96.7 Million

Locust Wood hiked its stake in Liberty Ventures (NASDAQ:LVNTA) by 3% during the fourth quarter, which, coupled with the greater than 10% rise in the company’s stock during that period, cemented Liberty Ventures (NASDAQ:LVNTA)’s place at the top of the fund’s equity portfolio. However, it remains to be seen if the company can hold on to that spot during this quarter, as shares of Liberty Ventures have been on a gradual decline since the start of the year and are currently trading down by nearly 27% year-to-date. Last November, Liberty Interactive Group announced that it would be spinning off CommerceHub and Expedia Holdings to holders of Liberty Ventures Group’s stock. The completion of each of the spinoffs is expected to occur within the first-half of this year. Following these spinoffs, Liberty Ventures will be comprised of all of Liberty Interactive’s businesses and assets, other than those attributed to the QVC Group.

Disclosure: None