Steel City Capital, an investment management firm, published its second quarter 2021 investor letter – a copy of which can be downloaded here. A quarterly portfolio net return of 3.2% was recorded by the fund for the second quarter of 2021. Year-to-date, the Partnership gained 11.1%, net. You can view the fund’s top 5 holdings to have an idea about their top bets for 2021.
In the Q2 2021 investor letter of Steel City Capital, the fund mentioned Trupanion, Inc. (NASDAQ: TRUP), and discussed its stance on the firm. Trupanion, Inc. is a Seattle, Washington-based pet insurance company, that currently has a $4.5 million market capitalization. TRUP delivered a -5.15% return since the beginning of the year, while its 12-month returns are up by 132.07%. The stock closed at $113.55 per share on July 26, 2021.
Here is what Steel City Capital has to say about Trupanion, Inc. in its Q2 2021 investor letter:
“Going forward, I intend to spend less time writing about the Partnership’s short positions for a variety of reasons including 1) the relatively small size of individual positions (generally 1-2%) which reduces the impact of any single one on overall performance and 2) the heightened risk of triggering a squeeze by the “Reddit-mob.” That said, I do want to comment on one position that I’ve discussed at length in previous letters: Trupanion (TRUP).
Blame it on a failure of imagination on my part, but TRUP management has found yet another way to apply window dressing to their otherwise deteriorating fundamentals. PAC growth has been explosive – TRUP exited 2020 at $272/pet acquired (ex. SBC) – 22.5% higher than 4Q’19 and an all-time nominal high. Based on initial guidance for 2021, I had penciled out average PAC at $315/pet, some 27.5% higher than the prior year average.
Naturally I was surprised when 1Q’21 PAC came in at $279/pet, reflecting y/y growth of “only” 13%. Moreover, management commented that they are targeting average PAC of $280/pet for the full year, effectively flat to first quarter levels and nowhere near my estimate of $315/pet.Did I miss the mark with my forecast? Not so fast…
Management also casually slipped in the following comment during the earnings call: “We expect stock-based compensation to be around $6-$7 million per quarter for the remainder of the year.” Coupled with the $8.4 million of SBC already booked in 1Q’21, TRUP is on track to recognize ~$28 million of SBC expense in 2021. Putting this figure into perspective, it is 3x higher than last year’s $8.9 million of total recognized SBC expense. Last year SBC expense was 1.8% of revenue; this year it will be 4.1%. What does SBC have to do with PAC and IRR? Well, for the purposes of calculating PAC, which is a key input into the IRR calculation, management excludes SBC because it’s non-cash. By upping the portion paid in the form of equity, management is artificially reducing the level of PAC incorporated in their IRR calculation. In 1Q’21, fully-loaded PAC (including SBC) was $328/pet, representing 22.4% y/y growth. SBC embedded in Sales and Marketing was ~$50/pet, which was significantly above historical levels ($20/pet). Had SBC been more in-line with historical levels ($20/pet), PAC (for the purposes of the company’s IRR calculation) would have been ~$310/pet…much closer to the full year figure I was expecting.
Photo by Mia Anderson on Unsplash
Based on our calculations, Trupanion, Inc. (NASDAQ: TRUP) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. TRUP was in 17 hedge fund portfolios at the end of the first quarter of 2021, compared to 18 funds in the fourth quarter of 2020. Trupanion, Inc. (NASDAQ: TRUP) delivered a 35.94% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
At Insider Monkey, we scour multiple sources to uncover the next great investment idea. For example, pet market is growing at a 7% annual rate and is expected to reach $110 billion in 2021. So, we are checking out the 5 best stocks for animal lovers. We go through lists like the 10 best battery stocks to pick the next Tesla that will deliver a 10x return. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. You can subscribe to our free daily newsletter on our homepage.
Disclosure: None. This article is originally published at Insider Monkey.
