Silver Ring Value Partners recently released its Q3 2020 Investor Letter, a copy of which you can download here. The fund posted a return of 6.9% for the last 12 months (net), underperforming its benchmark, the Russell 3000 Index which returned 15% in the same period. You should check out Silver Ring Value Partners’ top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Silver Ring Value Partners highlighted a few stocks and Qurate Retail Inc. (NASDAQ:QRTEA) is one of them. Qurate Retail Inc. (NASDAQ:QRTEA) provides e-commerce services. Year-to-date, Qurate Retail Inc. (NASDAQ:QRTEA) stock gained 67.3% and on November 5th it had a closing price of $8.11. Here is what Silver Ring Value Partners said:
“Qurate Retail (QRTEA)
The company’s business is primarily interactive selling via the QVC and HSN brands. Despite the rise of Amazon and online retail, sales have been relatively stable over the last 5 years. The key to this business is a loyal cohort of customers that account for ~85% of sales. These customers are incredibly sticky and have formed a strong recurring habit of shopping on the company’s platforms. They make ~20 purchases per year and their habit of shopping with QVC/HSN has not been meaningfully disrupted by the growth in other forms of retail. It is this cohort that makes this business predictable and makes any rapid declines in revenues unlikely.
The business is not without its challenges. The integration of HSN over the last 2 years has caused issues, and led to a low single-digit decline in sales in 2019. The previously acquired Zulilly business has not done well, although it now accounts for less than 10% of profits and is not material to the overall value of the company. Also, as pay TV loses subscribers in the U.S., it becomes harder for the company to acquire top-of-funnel customers via its TV networks.
On the bright side, the company has benefitted from the COVID pandemic, which caused a spike in demand in Q2, which likely continued into Q3. The reason this is important to the long-term value of the business is not the temporary bump in sales, but the increase in top-of-funnel customers. Historically there has been a steady relationship between top-of-funnel customers and the number of loyal cohort customers which account for most of the company’s value. So far the new cohorts are showing similar behavior to those of the past, suggesting a permanent step-up in value from the impact of COVID on the company.
The opportunity came about as a result of management taking an unusual capital allocation step. They announced a two-part special dividend, the first in the form of cash and the second in the form of preferred stock. The remaining equity component will have reasonable leverage (around 3.25x Debt to EBITDA, and around 4x Debt + Preferred to EBITDA). By separating the equity into a fixed component (the preferred equity) and the remaining variable component (the common equity), management was highlighting the absurdly low valuation on the equity. At the time the special dividends took place, the equity was valued slightly above 3x EPS/FCF. To be clear – that’s not based on some theoretical future number, but on the actual run-rate results that the company has achieved in the first half of this year, during a recession.
As an interesting aside, and a possible explanation for why the opportunity exists, I mentioned this special situation to 3 smart, experienced investors at different large firms. As far as I know none of them invested or decided to do serious work on the company. Why? My sense is that their analysis stopped at “isn’t this a declining business?” Maybe, maybe not. However, none of the three came back with an analysis of why the plausible rates of decline would make the equity worth less than where it is today, even in the worst case. Given that 85% of sales comes from a loyal cohort of customers and is largely recurring, it would be hard for the business to decline at a rate that would make the company worth only 3x free cash flow. I suspect their reaction was caused by a combination of visceral revulsion to a business that does have some secular challenges combined with a mental fatigue with value stocks that are cheap, but where it’s not clear how/when the market will re-rate their valuation higher.
On the last point, I suspect that management is not done. Having isolated the common equity from the preferred, I would expect them to use the free cash flow stream to aggressively buy back shares. If I am right, then we are rooting for the stock to not rise too rapidly, so as to allow them to retire as many shares as possible cheaply.
I rate Business Quality as Above Average (2 out of 5) due to the predictable demand from the loyal cohort of customers. Management as Average (3 out of 5), and the Balance Sheet as Average (3 out of 5). At the time of initial purchase the stock was at 36% of my Base Case value and was trading below my Worst Case value estimate.”
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In Q2 2020, the number of bullish hedge fund positions on Qurate Retail Inc. (NASDAQ:QRTEA) stock increased by about 34% from the previous quarter (see the chart here), so a number of other hedge fund managers believe in Qurate Retail’s growth potential. Our calculations showed that Qurate Retail Inc. (NASDAQ:QRTEA) isn’t ranked among the 30 most popular stocks among hedge funds.
The top 10 stocks among hedge funds returned 185% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 109 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds’ poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.
Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.
