2020 Third Quarter Letter

Your portfolio had a strong start in the third quarter before taking a pause in September.  Your account specific results are on the enclosed “Performance Report”.  For comparison, during the third quarter the Russell 2000 Value Index improved 2.6%, the Russell 2000 Index rose 4.9%, while the S&P 500 increased 8.9%.  Year-to-date the Russell 2000 Value Index is down 21.5%, the Russell 2000 Index fell 8.7%, while the larger capitalization S&P 500 is up 5.6%.  (For index descriptions, please see the Client Login section of our website.)

Today correlations exist between many current market statistics and the technology bubble of the late 1990s and early 2000s.  The market’s concentration is extreme; approximately 25% of the S&P 500 is comprised of the five largest companies (renowned technology names).  This meaningfully surpasses the previous high reached in 2000.  The valuation differential between the growth and value styles is also beyond what was seen at the peak of the technology bubble.  Initial public offerings have soared to the highest level since the bubble.  Finally, the Russell 1000 Growth Index (large cap growth) is up 24.3%, far outpacing the Russell 2000 Value Index’s (small cap value) 21.5% decline – an unimaginable 45 percentage point spread in only nine months.

Historically, when these trends reversed it was powerful!  For perspective, over the five years beginning January 1, 2000 the Russell 2000 Value Index was up over 121% while the Russell 1000 Growth Index declined nearly 39%.  We are not predicting a repeat, but we do believe it is instructive when considering possible future market paths and asset allocations.

In the quarter we added NMI Holdings to your portfolio.  NMI is a rapidly growing mortgage insurer with strong underwriting and a risk pricing engine that yields them a competitive edge over their larger competitors.  In addition, we hypothesize that the strength of the housing market driven by historically low interest rates and by COVID will allow NMI to avoid significant losses.  Also new to your portfolio is Vishay Precision Group.  Vishay provides precision sensors to a variety of end markets.  We expect accelerating organic growth to drive meaningful margin improvements.  Finally, increasing adoption of the internet of things (IoT) technology should be a tailwind to their business for the foreseeable future.

The sale of Benefytt Technologies in the quarter generated cash needed for these purchases.  Benefytt announced they were being acquired at $31.00 a share, a meaningful premium to its recent share price.

Thank you for your confidence.  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.

2020 Second Quarter Letter

We hope you are healthy and well.  Portfolios enjoyed a solid rebound this quarter.  Your account specific results are on the enclosed “Performance Report”.  For comparison, during the second quarter the Russell 2000 Value Index rose 18.9%, the Russell 2000 Index jumped 25.4%, while the S&P 500 was up 20.5%.  Over the first half the Russell 2000 Value Index dropped 23.5%, the Russell 2000 Index declined 13.0%, while the S&P 500 is down 3.1%.  (For index descriptions, please see the Client Login section of our website.)

This recession was caused by unemployment; traditionally unemployment is an outcome of a recession.  As a result, companies rapidly cut costs, Congress moved quickly to put money in the hands of consumers and the Fed cut rates before economic damage was obvious.  The combination of these actions blunted the impact of the near halt to the economy.  Today the economy is showing multiple signs of rebounding off the April lows.  As was the case in 2008/2009, portfolio executives are talking about exiting the recession stronger than they entered.  We believe our strong management teams’ ability to think this way is largely a function of their low debt.  Another positive signpost we saw this quarter was an increase in insider buying.  Activity was especially pronounced in April but has continued since.

During the quarter we bought Barrett Business Services after selling it earlier this year nearly $50/share higher.  Incredibly, recent company changes position it better than when we sold.  After Fluent dropped in the March meltdown we increased the weighting.  Fluent is making compelling changes that appear to be accelerating its growth.  TriState Capital was pummeled when the market fell.  After reanalyzing the business, we concluded they were in fact benefiting from the economic circumstances and increased the weighting at a price 50% below the prior purchase.  Early in the quarter Bonanza Creek Energy and VAALCO Energy were trimmed slightly to reduce the risk we saw coming from oil storage filling near capacity.  ChromaDex was also trimmed when the stock price jumped, and the weighting rose, after the company announced promising coronavirus immunity research.

Increasing data from third parties indicates that small value is the market segment with the largest rebound out of recessions.  This is also our experience.  The underlying fundamentals of the portfolio combined with the stock price drop we saw in the meltdown lead us to believe history likely repeats itself.

Your confidence, personal concern and patience are appreciated.  We believe the portfolio is positioned well for future economic improvements.  The Privacy Notice is enclosed for your review.  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.

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.