2020 First Quarter Letter

We hope you and your family are healthy while appreciating the additional time together.  The start of 2020 will be forever etched in our memory for both the life changes experienced as well as the indiscriminate drop across global financial markets.  Your account specific results are on the enclosed “Performance Report”.  For comparison, during the first quarter the Russell 2000 Value Index was down 35.7%, the Russell 2000 Index fell 30.6%, while the larger capitalization S&P 500 declined 19.6%.  (For index descriptions, please see the Client Login section of our website.)

Although no one can be certain when the health crisis will end, we are confident the U.S. economy was solid and even appeared to be accelerating heading into the COVID-19 outbreak.  The government has since committed more monetary and fiscal stimulus in a shorter time frame than any period in our lifetime, with talk of more to come.  It is our belief these factors meaningfully enhance the ability of the economy to rebound once we return to a semblance of normal life.

We are encouraged that your holdings do not include any restaurants, retailers, hotels, or airlines.  However, the energy holdings weighed on the portfolio.  Our disciplined approach to limiting portfolio debt levels leads to minimal concern about the survival of any of the companies owned.  The portfolio at 5.2x forward 12-month consensus earnings estimates and 0.6x book value are both below the low experienced during the financial crisis.  When considering these dynamics, we are highly optimistic about the future upside of the portfolio once fear subsides and there is more clarity of our economic future.

During the quarter, a new position was initiated in Bonanza Creek Energy.  The management team is top notch and the company is an efficient producer with big data management systems similar to what the best of their much larger peers possess.  We added to existing positions in Fluent, Green Brick Partners and TriState Capital.  We strongly believe each will add impactful value to your portfolio over the next several years.  We exited Helix Energy Solutions and Barrett Business Services because the upside appeared limited after their stock price increases lead to valuation concerns.

Thank you for your immense patience and confidence in our research.  In this surreal environment we believe our actions today are aligning the portfolio to rebound in a future improving economy.  Form ADV Part 2 was e-mailed to you earlier this year.  If you didn’t receive the e-mail and would like a copy, please contact us.  Alternatively, it is also available on the TietonCapital.com website.  As always, if the circumstances surrounding your account change such that you believe we should review the suitability of your assets managed by Tieton Capital, please contact us immediately.

2019 Fourth Quarter Letter

The decade closed with the toughest year relative to the indexes since 2008.  Simply put, it was a weird year for the portfolio.  The valuation relative to the market is extraordinarily compelling today and the catalysts have powerful developments materializing.  The currently depressed level appears to set the portfolio up for significant outperformance, which also occurred after we lagged in 2008.  Your account specific results are on the enclosed “Performance Report”.  For comparison, in 2019 the Russell 2000 Value Index increased 22.4%, the Russell 2000 Index rose 25.5%, while the larger capitalization S&P 500 roared 31.5% fueled by big tech companies.  (For index descriptions, please see the Client Login section of our website.)

This quarter we initiated a new position in Green Brick Partners, a home builder focused on fast growing metropolitan areas.  After sluggish industry wide home sales tied to rising interest rates a year ago, Green Brick is accelerating new community openings.  In addition, they hired an experienced leader to enter the first-time buyer market.  Tristate Capital Holdings was purchased before they reported third quarter earnings, following a meeting with management at their Pittsburgh headquarters.  The stock price jumped after the report and continued to move up since.  Apogee Enterprises was trimmed in the third quarter after the stock price rose on a good earning’s report.  This quarter earnings were impacted by a temporary hiccup in the Framing Segment.  This created an opportunity to repurchase shares after meeting with management in Minneapolis about $10 below the price it was trimmed a few months ago.

Two of the smallest weightings and lowest confidence positions in the portfolio were sold.  CARBO Ceramics is taking longer to transition into industrial markets than anticipated.  Combined with the unanticipated loss of a large oilfield contract, we believe CARBO will now struggle to generate meaningful profitability over our time horizon.  Consequently, the position was sold.  SandRidge Energy was sold after the company announced the CEO was leaving.  Prior to his departure, acquisition discussions were underway to build a platform for production growth.  We were patiently waiting for the company to announce an acquisition before increasing the small weighting.  However, the changed circumstances led us to reverse course.  Steelcase reported better than expected earnings, but future orders were indicated softer.  Hence, the stock was sold after the price rallied.  Regional Management’s weighting grew to one of the largest in the portfolio as a result of the strong stock price.  Next year earnings are likely to have a headwind from a new loan loss accounting rule.  This combination led us to trim the position.  If the shares pull back, we would gladly repurchase them in this well-run company.

The year was very frustrating but our confidence in the research is high.  Thank you for your patience in our process.  As always, if the circumstances surrounding your account change such that you believe we should review the suitability of your assets managed by Tieton Capital, please contact us immediately.

2019 Third Quarter Letter

In September the portfolio began to improve and reflect positive company fundamentals after a period of illogical pressure.  Your account specific results are on the enclosed “Performance Report”.  For comparison, in the first nine months of 2019 the Russell 2000 Value Index is up 12.8%, the Russell 2000 Index rose 14.2%, while the larger capitalization S&P 500 increased 20.6%.  (For index descriptions, please see the Client Login section of our website.)

We are pleased with how your account is positioned and its unusually compelling valuation.  Half the companies are trading at or below 10x the next 12 month’s forecasted earnings.  Last quarter this same statistic was 12x earnings.  Despite the portfolio companies reporting second quarter earnings growth, the stock prices irrationally declined.   As a result, the valuation became more enticing.  We patiently await the market recognizing the high quality, low-debt companies for their earnings fundamentals and favorable prospects.

No new purchases or complete sales of existing positions took place this quarter.  We researched many new companies, but none motivated us to initiate a trade relative to the portfolio holdings.  We believe this bodes well for future results of the companies owned.  Geospace Technologies was the most significant activity in the quarter.  We meaningfully raised the weighting in advance of what appears to be increasing rentals of their new offshore seismic product, as well as heightened interest within the U.S. government to purchase their revolutionary border security offering.  AdvanSix and Medallion Financial were both increased early in the quarter in response to their catalysts nearing fruition while their share prices pulled back.  ZAGG was increased shortly before they announced hiring an investment banker to explore the sale of the company because investors aren’t recognizing the value of the business.

Funds for the purchases this quarter came from several positions that were trimmed.  Apogee, Barrett, Steelcase and Insight Enterprises were reduced when we concluded that the size of these positions was not justified by the forecasted upside over our two-year time horizon.  Since Insight was trimmed, they closed an attractive acquisition that may lead to improved growth prospects.

Please alert us if you are not receiving statements from your custodian at least quarterly.  In addition, your custodial statement should be compared with the report we send you.  As always, if the circumstances surrounding your account change such that you believe we should review the suitability of your assets managed by Tieton Capital, please contact us immediately.  Thank you for your confidence.

2019 Second Quarter Letter

The low level of debt in the portfolio is especially comforting with the uncertainty surrounding global trade and perpetual concerns of economic activity slowing.  Your account specific results are on the enclosed “Performance Report”.  For comparison, during the first half of the year the Russell 2000 Value Index was up 13.5%, the Russell 2000 Index jumped 17.0%, while the larger capitalization S&P 500 rocketed up a first half record 18.5%.  (For index descriptions, please see the Client Login section of our website.)

Investor uncertainty led many companies in the portfolio to trade at levels that appear wildly inconsistent with the value of the assets.  In stark contrast to the popular “FANG” stocks, over half the companies in the portfolio are trading at less than 12x their forecasted income in the next 12 months, while approximately 75% are trading under 2x book value.  As confirmation of what we believe are undervalued businesses, we see an increasing number of companies repurchasing stock and officers buying shares.

Nearly a year ago Myriad Genetics was sold after the stock price became fully valued and better alternatives were identified.  The stock price fell significantly after our exit.  A visit to the company in February provided confidence reimbursement for currently unreimbursed tests would increase dramatically.  Additionally, a medical review in the next year could nearly double their core market.  As a result, during the first quarter we began rebuying Myriad.  The second round was finished this quarter.

Atlas Financial was our biggest disappointment in years.  The company made successful process changes over the last three years that appear to be leading to lower claim payments.  However, our premise that reserves would not require further strengthening was wrong.  The ensuing loss from increasing reserves reduced capital levels to concerning levels.  We think they will need to raise additional capital and dilute shareholders.  As a result, the shares were sold.  Helix Energy Solutions was trimmed due to uncertainty around renewal pricing of contracts that conclude in a couple of years.

Thank you for your patience.  The low level of trading in the second quarter indicates our conviction in the portfolio.  We visited many companies already this year and our enthusiasm is high for what the company leaders are creating.  If it weren’t for our on-site visits and our ongoing research into how the businesses are developing, it would be difficult to be as patient as you.  Once again, thank you for your confidence in our analysis and patience with the process.

Our Privacy Policy is included with this report.  Please contact us with any questions regarding this policy.  As always, if the circumstances surrounding your account change such that you believe we should review the suitability of your assets managed by Tieton Capital, please contact us immediately.