2011 Q2 Results. Underperforming but Not Out.

Jae Jun

OSV Portfolio Performance

As you can see, I’m having a tough time of it this year. YTD I am down 4.6% which is more than 10% behind the S&P500 and Russell 2000. It’s times like this I’m glad that I can say that “past performance is not an indication of future performance” 😛

For the second quarter of 2011, my portfolio was -7.19% compared to break even for the S&P500 and -1.61% for the Russell 2000.

The reason for such negative performance stems from my biggest holding in HHC and GRVY, weakness in commodities and a value stock continuing to get hammered.

As this is a portfolio overview, I won’t be getting into specific numbers for every company I discuss as I am just writing this off the top of my head.

Biggest Holdings

Two of my biggest holdings are HHC and GRVY. These two stocks alone make up 27% of my portfolio but I am not concerned at all about the recent drops.

Howard Hughes Corp (HHC)

Since the spinoff from GGP, HHC continues to support the theory that spinoffs make great investment opportunities. Insiders have been snapping up shares and they own a big chunk of it. Both residential and commercial land sales have been ticking up. The real estate market still hasn’t fully recovered but HHC is being active in acquiring high quality property along. Undervalued assets on its book make it a nice hold.

Gravity (GRVY)

GRVY has been a big disappointment so far. The release of their flagship game RO2 has once again been delayed to Q4 of 2011. This is probably the third time the game has been delayed since I have owned the stock, and is the cause of the price drop. Down 15% QTD.

With that said, the upside still remains. All these delays are related to business risk but the fact remains that the company is still profitable, they have been adding new titles and if  you look at the quarterly numbers, game subscriptions are increasing as well as revenue from mobile gaming which is a huge industry nowadays.

The company is still a net net.

A net net stock with low capital expenditures and operating profits is the the type of company I am willing to wait and bet on. It hasn’t been easy waiting these past couple of years, but the hardest thing to do in investing is to just stay still.

The latest game delay only caused a price drop of 6%. If it was any other company you would have seen the stock crash at least 20%, but GRVY offers a huge margin of safety which is also why I continue to remain strong on this company.

Weakness in Commodities

Although the market has rallied, commodities did not follow suit. I do not invest based on macroeconomics, but I just can’t ignore the ultra low interest rates, increasing trade deficit, national debt and a weakening dollar that should have a big impact on the prices of commodities over the next few years.

Commodities bring with it huge amounts of volatility, but by focusing on the mid to long term, I’m betting that my exposure to commodities will be a profitable one in the end.

Yukon Nevada Gold

This junior gold miner is the biggest loser and a hindrance to the portfolio at the moment being down 47.3% as of end of Q2. In Q2 alone, YNGFF has fallen 32.65%. Ouch.

I must have gone over the investment thesis for YNGFF about 5 times the past few months in order to determine whether I was missing out on something with the huge volatility and price drops witnessed by the stock. The conclusion each time has been that price is a tool and not an indicator of the company. This was confirmed by a press release stating that the company was not aware of any business activity that could materially affect the stock prices in such a fashion.

I mentioned in previous posts that YNGFF needed capital to update and winterize its facilities, and with the winter forcing YNGFF to halt operations, the company was unable to create enough cash from operations to fund the maintenance and upgrade plan.

In need of capital, management allowed its existing warrant holders to exercise at a 18% discount. You can’t blame these holders for immediately selling upon exercising.

The short term for YNGFF is stomach churning, but if management is able to achieve the stated goal of 150k ounces by end of 2011, I expect the stock price to lift off beyond $1.00 easily, and that is an understatement.

Value Stocks getting Crushed

Aeropostale (ARO)

Down roughly 30% in Q2 and 7% in June. Definitely not an investment that will work out in the near future but with the value of the stock, it’s a position that I am willing to hold and wait for. The latest drop came due to a rise in cotton prices which has affected the bottom line.

ARO isn’t the best clothing retailer out there and given the chance, I would jump at the opportunity to buy BKE, but with ARO trading below $20 and the value metrics it offers, ARO is going to be on my hold for three years and see. Given the positive FCF and health of the company, the company isn’t one that I am worried about going bankrupt.

My performance is under performing but based on margin of safety and the upside each holding offers, I’ll be able to get back in the game with a few big jumps.

Books a Million (BAMM)

I sold the position completely. The reason for buying the position to begin with was based on the fundamentals, consistency and because traditional books stores are hated by everyone.

While I don’t believe traditional brick and mortar book stores will disappear, I have succumbed to the conclusion that the industry will become smaller and BAMM will not be able to achieve returns on equity sufficient enough to maximize value.

In other words, BAMM has become a value trap. It is trading at 50% to book value, but the worsening economics and declining profitability will slowly erode the value of the stock down to where it is trading today.

The author of an article on seekingalpha does an excellent job working through all the fundamentals, but my conclusion is that this is a value trap.

I wouldn’t be surprised to see tiny losses more often now when the company reports quarterly.

OSV Passive Model Portfolio

Now time to update you on how my passive model portfolio is doing.

2011 YTD Performance Graph: +15% Price Return

2011 Q2 Performance Graph: Approx -2.5%

The model portfolio fell quite a bit this quarter as well. I removed KIRK, CMTL, BOLT and HPOL from the list in the quarter and added RIMG, DLB and LXK based on fundamentals.

Remember that this is a purely fundamentals based passive portfolio. I just ran it through the stock valuation software, checked the fundamentals, dwelled on the value based on the business position and industry and then added it to the list without much hesitation.

The performance is still doing fantastic. YTD, the price return is +15%.

As I am the one that selects which stocks to add, the model portfolio result seems to indicate that my current investing behavior includes emotion and hesitation which is affecting my overall decision and performance.

Since inception, the portfolio is up about 53% compared to the S&P 500 return of approx 20%.

OSV Passive Model Portfolio Holdings

(click to enlarge)

Disclosure: Long HHC, GRVY, YNGFF, ARO

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