Update No. 255 – 19/02/16

I described the current market as a ‘Caspar Milquetoast Market’ last weekend, the market that ‘speaks softly and gets hit with a big stick’.

Well, Caspar stood up for himself this week, with our benchmark rising by over 4% despite a decent fall today.

EGP had an excellent week all things considered too. We didn’t quite keep pace with the fast rising markets, but we had seven results come out this week, with five exceeding my expectations, and two pretty much as expected. If I restrict the portfolio to these positions, we gave the market a lesson this week, but with the other positions, including a big Friday fall in one of our illiquid positions; we fell short of the markets gains.

I thought this week I might discuss a rare short-term position we took this week. The position was initiated Wednesday, augmented Thursday and closed Friday. Sometimes reporting season throws up quirky opportunities and Sims Metal Management (SGM.ASX) was such an opportunity this week. Such very short term actions are extremely rare for EGP, but any opportunity that looks sharply mispriced will get my attention. After not making the most of uncovering opportunities such as Slater and Gordon, which we foresaw and wrote about extensively in the blog, I have decided that when a high probability short-selling opportunity comes up, we will exploit it if we can.

Thanks must go to Max Shramchenko and Nigel Littlewood of Harness Asset Management, who crystallised my actions this week with a conversation we shared last week about SGM. SGM were due for a horrible half, and after Max went through the story, I agreed with his view that despite big falls over the last 12 months, the half was likely to be worse than guidance and consequently, they would guide down the second half of FY16 and beyond. Recent low Iron Ore prices have seen the availability of scrap metal (SGM’s primary stock in trade) fall off a cliff. Inevitably, when the price of Iron Ore falls, the price of scrap will follow. At a certain point, it becomes uneconomic to bother collecting the scrap and taking it to the merchant… With revenue falling at a breakneck pace, it’s an adroit management that can keep pace with cutting cost out of the business; I didn’t think SGM had such a management (to be sure, I don’t envy them the task).

In any case, I thought the risk/reward of buying some short-dated (February 25^th) Put Options made sense as a way to exploit what I thought was a high probability that the stock would fall post earnings announcement/market update.

On Wednesday, I spent $2,350 (plus brokerage) of our funds for 100 x $7.50 puts (giving me the right to sell shares at $7.50).

On Thursday, I spent $210 (plus brokerage) for 42 x $7.00 puts (giving me the right to sell shares at $7.00). What I actually bid for Thursday was another 300 options, but the markets are pretty thin and the volume wasn’t there (unfortunately as you will see) so we only got the 42.

On Friday, after market opened and the stock began cratering as holders realised how dour a situation SGM face. When the stock was trading at around down from Thursdays close of $7.76 to $7.10, I liquidated the positions (too soon unfortunately as it fell below $6.70 intraday – timing is hard). We got $5,000 (less brokerage) for the 100 x $7.50 puts and $1,900 (less brokerage) for the 42 x $7.00 puts.

We made a little over $4,250 after costs. Had we managed to acquire the full 300 x $7.00 puts we bid for, we would have made closer to $15,000.

Both of these amounts are relatively small even for a little $5m fund such as ours, but the $15k profit is around 0.3% of $5 million, we only need to find a 0.3% opportunity 10 times per year to add 3% to annual performance. We shall keep scouting for such opportunities. In the meantime, if the roughly 20 positions left to report are half as good as the first seven, we will have a very good reporting season – Tony Hansen 19/02/2016

EGP Fund No. 1 Pty Ltd. Up by 5.02%, leading the benchmark by 10.15% since July 1^st 2015. Since inception, EGP Fund No. 1 Pty Ltd is Up by 95.01%, leading the benchmark by 65.60% all-time (April 1^st 2011).

^{*1 after a 31 May 2013 dividend of 2.333 cents per share (cps) plus 1.000 cps Franking Credit, a 31 May 2014 Dividend of 7.000 cps plus 3.000 cps Franking Credit and a 31 May 2015 Dividend of 8.6667 cps plus 3.7143 cps Franking Credit}

^{*2 calculated based on dividends reinvested}