Smart Money Masters — March 2017 Issue

Introducing a New Investment Strategy that Follows the Masters

Welcome to the first issue of Smart Money Masters!

As I hinted last week, my publisher and I have been working hard to revamp the format of the Alpha Investor Letter.

Smart Money Masters is replacing your Alpha Investor Letter subscription starting this week. All of the terms of your current subscription will remain in place.

You may have noticed that I have been focusing more on tracking the biggest bets of Wall Street’s “smartest money.”

My three most recent recommendations have included George Soros’ top bet, Liberty Broadband (LBRDK), Bill Ackman’s #1 pick, Restaurant Brands International (QSR), and Warren Buffett’s biggest play, Kraft Heinz (KHC).

These recommendations have a couple of things in common.

First, some of the best investors in the world have put both their money and reputations on the line by investing big in these positions. You can be sure that the smartest minds in finance put a lot of thought into these investments before they made them.

Second, these positions aren’t household names. Chances are you hadn’t heard much about George Soros’ #1 bet, Liberty Broadband (LBRDK), before. Yet, that position is up 22.42% just since Nov. 11.

Smart Money Masters’ first recommendation, Navigator Holdings Ltd. (NVGS) — billionaire investor Wilbur Ross’ top investment — follows this same approach.

Each issue of Smart Money Masters will also include some color on one of these investing greats, including a “Meet the Manager” personal profile, a discussion of the investor’s investment philosophy and other unique tidbits. I think you will enjoy it.

Finally, I’ve screened all of your current Alpha Investor Letter recommendations through the new Smart Money Masters methodology.

Based on this, I am recommending that you close your positions in The Walt Disney Company (DIS), Alphabet (GOOGL), Cambria Global Value ETF (GVAL), WisdomTree Emerging Markets SmallCap Dividend Index (DGS), Home Depot Inc. (HD), iShares Currency Hedged MSCI Germany (HEWG), NVIDIA Corporation (NVDA) and the Guggenheim S&P 500 Equal Weight ETF (RSP).

You are exiting every one of these positions at a profit. Your gains in these stocks range from 1.43% for the iShares Currency Hedged MSCI Germany (HEWG) ETF to 151.21% in NVIDIA Corporation (NVDA).

All of your remaining Alpha Investor Letter positions will be transferred to your new Smart Money Masters portfolio.

Investment Philosophy

Wilbur L. Ross, Jr. is the founder of private equity firm WL Ross & Co. Now owned by Invesco, the firm manages more than $7 billion in assets.

Nicknamed the “King of Bankruptcy” for his experience in buying down-and-out companies, Ross is one of Wall Street’s leading experts in distressed investing. Real estate magnate and fellow billionaire Leonard Stern described Ross as “one of the best bottom feeders in the business.” Ross’ strategy focuses on buying crisis-ridden companies in distinctly unsexy industries such as steel, coal, telecommunications and textiles. He later sells these for a fortune after revamping their operations.

The deal that put Ross on the map was when he bought bankrupt steelmaker LTV for $325 million in 2002 — and sold it for $4.5 billion two years later to ArcelorMittal. He made $2.5 billion for his firm and $300 million for himself. Ross was also a big investor in European banks such as Bank of Ireland and National Bank of Greece at the height of the European financial crisis.

Unlike classic private equity raiders, Ross prides himself on having a very open and frank relationship with unions. In each of his factories, the senior manager must meet with the local union representation at least once a month and go over in great detail how that factory is doing, how the company is doing, where they’re doing well and where they’re doing poorly. Unions are free to audit a company’s books at any time. Ross also believes in productivity bonuses for blue-collar workers: a fair base salary and substantial increases in their pay if they achieve targeted productivity goals.

Ross attributes his success to simplicity and execution.

“I think good ideas really are simple ideas,” Ross said. “I’d rather back a mediocre idea that was brilliantly executed than a brilliant idea that was poorly executed.”

Ross also has said that an investor must manage not only financial risk, but also his own emotions. As he puts it, “To be successful, you have to be able to keep your emotions separate from the decision-making process.”

Two books have influenced Ross’ thinking the most. The first, written by Benjamin Graham and David Dodd, is “Security Analysis.” That book is widely considered the bible of value investing. The second book Ross cites is Yale University professor Robert Shiller’s “Irrational Exuberance,” which offers a more psychological perspective on financial market bubbles.

Meet the Manager

From Aspiring Writer to Billionaire to Commerce Secretary

T he son of a judge, Wilbur Ross grew up in New Jersey and attended a Jesuit military academy in Manhattan. While studying at Yale University, Ross wanted to be a creative writer. But Yale had a course called “Daily Themes” for which he had to write 500 words of prose each day.

By the third week, he was both out ideas and out of the course. Today, Ross says dropping the course saved him from a life of poverty. He then ended up on Wall Street by pure chance. Yale’s treasurer, who had taken a liking to Ross, had left the university to join a money management firm. He offered a job to Ross, who accepted it, even though he was reluctant to give up his previous summer position parking cars at the Plymouth Park Jockey Club.

Ross later earned an MBA at Harvard Business School and worked for 25 years at the investment bank, Rothschild. In 1997, he started a $200 million fund at Rothschild to invest in bankrupt companies. Within three years, he bought out Rothschild. On April Fool’s Day, 2000, Ross went into business for himself, founding his private equity firm, WL Ross & Co.

By 2005, Forbes magazine listed Ross as one of the world’s billionaires. He is currently ranked #232 in the Forbes list of the 400 richest Americans, with an estimated net worth of $2.5 billion.

Although he was an early supporter of President Trump’s campaign, Ross was a registered Democrat for many years. He even served as an officer of the New York State Democratic Party. Ross began donating to Republican candidates in 2011 at the ripe age of 73. He only became a registered Republican in November 2016 when Donald Trump nominated him to be Commerce Secretary.

A Contrarian Bet on Global Shipping

Global shipping is a tough business.

When the global trade is expanding, high “day rates” ensure that shipping companies are making money hand over fist.

But when traffic slows, the shipping business is the picture of Darwinian ruthlessness. Weighed down by tumbling cash flows, shipping companies go bankrupt during economic downturns with remarkable regularity.

Shipping companies also expand their fleets at precisely the wrong time. Almost like clockwork, they place orders for too many ships at the top of the current trade cycle. When that cycle turns, shipping companies are left servicing massive debt on fleets they can’t use.

The entire industry suffers from overcapacity, which depresses the day rates shipping companies can charge when markets rebound.

So why would anyone ever want to invest in a shipping company?

Enter one of Wall Street’s top contrarian investors, Wilbur Ross.

Where most investors see risk, Ross sees opportunity.

By digging deeply into the structure of the shipping business, Ross believes that he can wring out profits from the shipping business even as other investors shout “abandon ship.”

Ross’ contrarian thinking is behind your very first Smart Money Masters recommendation, London-based shipping company, Navigator Holdings Inc. (NVGS).

Navigator Holdings owns and operates a fleet of 33 liquefied gas carriers. With its global footprint, the company loaded 14% of cargos in South America, 30% in Europe, 23% in Asia, 26% in the Middle East and 8% in the United States.

When Wilbur Ross bets on a contrarian opportunity, he bets big.

So it’s no surprise that his company, WL Ross & Co., is Navigator Holdings’ largest shareholder and owns 39.4% of its shares.

Let’s take a look at Navigator Holdings through Ross’ eyes, and why he was willing to invest in such a challenging sector.

Navigator Holdings’ Superior Business Model

Unlike most investors who avoid the shipping business like the plague, Ross recognizes that Navigator Holdings has a better business model than its mainstream shipping rivals.

That’s because Navigator Holdings operates in the one segment of the shipping industry that is thriving: the transportation of volatile oil and gas products.

Fracking and other technologies have unleashed an energy revolution across the planet. Production of LNG (liquid natural gas), LPG (liquid petroleum gas), ethane and ethylene has exploded in North America. The benefits of this technology also rapidly expanded to other energy centers like the Middle East and Russia.

As the demand for these inexpensive gasses and volatile liquids soars, so does the need for the liquefied gas carriers to ship these products from continent to continent.

Meanwhile, the technological flexibility of its vessels has allowed Navigator Holdings to transform itself from an LPG transporter to a broad-based shipper of LPG, LNG and other petrochemical gasses.

As Navigator Holdings’ CEO puts it:

“(O)ur business benefits from a geographical diversification, and that we are not dependent on any one geographical area or country for export volumes, nor are we dependent on any one product, we carry LPG, propane, butane, we carry ammonia, and a variety of petrochemical gasses. The rates and utilization of this trade tend to be far less volatile than, say, the very large gas carriers that have essentially carried propane from the U.S. or the Mid East to the Far East.”

Despite their excellent business prospects, broadbased shippers of petrochemical gasses are selling at the same discounts to underlying value as their long-suffering dry shipping counterparts. Investors who don’t understand the difference between them are throwing the baby out with the bathwater.

Luckily, Wilbur Ross is holding on to the baby.

A Value Play With 200% Upside Potential

Even after its recent run-up, Navigator Holdings remains a very cheap stock.

It currently trades at a low price-to-earnings (P/E) ratio of 10.7x. Navigator Holdings’ book value is $16.98 a share versus a current market price of $11.65 a share. That means its price to book value ratio is a lowly 0.68.

Even a conservative assumption that Navigator Holdings should trade at its book value would drive the stock up 47% from current levels.

But I’m betting Wilbur Ross is shooting for even more.

Ross knows that many shipping companies reach their peak valuations around 2x book value at the top of the economic cycle. At that level, Navigator Holdings could trade as high as $34.00, almost 200% above its current levels. This valuation is hardly out of the question for a company with one of the most robust balance sheets in the shipping sector.

A Bet on Navigator is a Bet on Wilbur Ross

Wilbur Ross’ investment in Navigator Holdings is the key to the company’s future success.

Ross made his first investment in Navigator Holdings in November 2011, after bringing the company out of bankruptcy. He became the majority shareholder in May 2012.

With a nearly 40% holding in the company, and Ross’ rigorous, private equity style of active investing, Navigator Holdings won’t be making the same poor investment decisions of its rivals.

David Butters, the CEO of the company, is also the second-largest shareholder, owning 3.5% of the company’s stock. Ross has made sure that management’s interests align with his own.

Overall, Navigator Holdings Ltd. offers a diversified play on a growing segment of the shipping industry, a solid balance sheet and strong operating earnings and operating cash flow.

Only because the company is lumped in with other dry shippers in the market is Navigator Holdings still selling at a significant discount to book value.

So buy Navigator Holdings Ltd. (NVGS) at market and set your stop at a wide $8.00. I have given this recommendation a risk rating of 3.

Sincerely,

Nicholas A. Vardy