It is extremely rare that hedge fund managers discuss in their quarterly letters specific companies they are currently shorting.
So, it is refreshing and instructive to read about the latest negative bets from Anthony Bozza, who founded $3.5 billion Lakewood Capital Management in 2007.
In his first-quarter letter, Bozza discussed in great specificity two shorts.
Bozza has a varied Wall Street background. He previously worked at New York hedge fund firm SAB Capital Management.
However, before that he spent time at alternative-asset giant KKR & Co. and as a mergers and acquisitions specialist at Gleacher & Co.
In the first quarter of this year, Lakewood was off 0.9 percent, despite surging more than 4 percent in March. The firm was up nearly 3 percent last year, 7 percent or so in 2014 and 13 percent in 2013.
At the end of March, Lakewood’s equity exposure was 77 percent long and 44 percent short, which works out to a 33 percent net equity exposure. It also was 4 percent long and 0.2 percent short fixed-income securities.
Although Lakewood’s five largest positions accounted for 23.4 percent of equity capital, the short positions are more interesting, if for no other reason that it’s so unusual to see a discussion about specific securities.
In the first quarter, Bozza told clients, the firm initiated a short trade in the food-processing business that specifically included Hormel Foods Corp. and Tyson Foods.
Hormel specializes in selling processed pork and turkey products, while Tyson is better known for its chicken, pork and beef products.
“Over the years, we have uncovered many of our best short opportunities in mundane and competitive businesses that have experienced a significant increase in their valuations, following an unsustainable increase in margins and earnings,” Bozza wrote.
He pointed out that since early 2014, Hormel’s stock has climbed nearly 75 percent and now trades at about 25 times earnings, which is very high. Bozza explained that a sharp rise in operating margins boosted earnings growth as investors bid up so-called safe consumer-staple stocks.
“We believe Hormel has benefited from an ideal environment for commodity pork processing that will soon normalize and force investors to return their focus to weak demand trends and the inherent volatility of the company’s commodity businesses,” Bozza told clients. He noted that while consumers are more familiar with Hormel’s popular brands like Spam, Applegate Farms, Jennie-O, Skippy and Muscle Milk, two thirds of the company’s profits have come from its low-margin commodity pork-processing and turkey-farming businesses.
“In addition to being volatile, these businesses both face secular pressures as per capita consumption of pork and turkey peaked in 1971 and 1996, respectively,” Bozza added. “Total consumption of pork and turkey has been declining for the last several years and Hormel has not reported organic volume growth since 2011.”
Bozza said he thought the stock was worth closer to $24 per share, or nearly 40 percent below levels when the report was written and 37 percent less than its current price.
Bozza said the Tyson story is similar, noting that the company is “benefiting from a cyclical tailwind that is nearing an end.”
“With the stock up 50 percent in the past six months, we believe there is significant downside as industry conditions normalize,” Bozza added.
He pointed out that in recent years the normally low-margin and volatile chicken business has seen its profitability steadily increase to record margins in 2015. However, Bozza added that chicken farmers are “starting to get greedy” and significantly increase supply at the same time that cattle inventories are rising after years of decline, which will make beef more price competitive.
Bozza says a number of factors will lead to lower profitability for Tyson. As a result, he thinks Wall Street estimates of high-single-digit earnings growth in 2017 “are overly optimistic.”