The Supervised Fund, managed by high conviction microcap manager David Constable, had a disappointing FY18, rising 5.4 per cent, lagging behind the 13.5 per cent returns of its benchmark.
The fund’s holding are uncorrelated to general stock market sentiment. The tiny microcap stocks in its portfolio are too small for most institutions, and are either unknown or out of favour amongst retail investors.
The fund often finds shareholders in such companies are relatively unsophisticated investors, and are often disgruntled long-term holders.
Such investors are often indiscriminate as to their sell price. They may be selling for tax loss purposes, portfolio spring cleaning, because they need to raise some cash now, or because they are simply bored, and want to move on to hotter stocks.
This behaviour allows The Supervised Fund to buy in cheaply, once it is confident of catalysts for growth in the short to medium term.
Since the shares of these companies tend to trade infrequently and on low volume, periods in between catalysts can result in considerable share price declines, even if there has been no change in the health of the company.
This can be frustrating, and a cause for short-term under-performance, something that has befallen the fund in FY18.
Zooming out, The Supervised Fund has outperformed its benchmark All Ordinaries Accumulation Index by 5.5 per annum since inception in December 2007.
Looking ahead, Mr Constable believes FY19 will be a year of considerable growth for The Supervised Fund, with a number of its holdings set for positive catalysts.
Kangaroo Island Plantation Timbers (ASX:KPT)
At 26 per cent of the fund’s net asset value, this is a very high-conviction position for The Supervised Fund.
Kangaroo Island Plantation is a listed timber company, managing a wholly-owned portfolio of hardwood and softwood forestry plantations and of cleared and uncleared agricultural land on Kangaroo Island, South Australia.
The company is sitting on 25,000 hectares of land on Kangaroo Island, on which 15,000 hectares is planted. As at 30 June 2018, the Board of Directors valued the standing timber at $108 million, an increase of 33 per cent over the last 12 months. The increase has largely been driven by strengthening prices for hardwood chip and softwood logs.
Kangaroo Island Plantation is in the process of completing an environmental impact study for its planned export facility at the Island. This process has taken longer than expected, and is now expected to be released in September 2018.
The Supervised Fund estimates approval for the export facility is likely to occur in early 2019.
Once Kangaroo Island Plantation begins harvesting its trees in around 2021, the fund expects it to generate free cash flow of over $20m per year, representing an 18% yield on its current market capitalisation of $109m.
The Kangaroo Island Plantation share price has fallen 13 per cent so far in 2018. KPT shares are currently trading at $2.09.
Hillgrove Resources Limited (ASX:HGO)
In its April report, The Supervised Fund said tiny copper producer Hillgrove Resources could generate $104m in free cash to equity holders by September 2020.
Since then, the Hillgrove Resources share price has fallen to 7.5 cents, giving it a market value of $43 million.
The Supervised Fund says from the December quarter of 2018, the company will begin to generate substantial free cash flow for equity holders, in the order of $8 to $11 million per quarter. This should allow Hillgrove to pay its first fully franked dividend since 2009.
Once it starts distributing cash to shareholders, the fund says Hillgrove should attract a market rerating.
Additionally, the fund says Hillgrove is currently marketing its proposed pumped hydroelectric energy storage system. If there are any interested parties, this could be worth up to $50 million. The fund is also expecting the results of two exploration programs in late 2019, which could extend the company’s mine life well beyond its current two years.
Hillgrove Resources is another high conviction position in The Supervised Fund, making up 12 per cent of the portfolio.
Po Valley Energy (ASX:PVE)
The fund says there are numerous milestones ahead for Po Valley Energy. It envisages the award of a preliminary production concession for its onshore gas field, Selva, in September 2018. The company will then undertake 3D seismic evaluation of the field, which could triple resources, increasing its net present value from about $18m to over $50m.
With the Po Valley share price trading at 4.3 cents, the company has a current market capitalisation of $25m. The fund expects these results in early 2019.
Further, the company is anticipating environmental approval for its offshore gas field, Teodorico, which has a net present value of about $44m. Following this, the fund says Po Valley Energy will be in a place to conduct a final investment decision, which would involve securing debt funding for the project, finding a JV partner, or wholly divesting the asset to one of the numerous major producers in the region.
Po Valley Energy is a 9 per cent position for The Supervised Fund.
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