2023 Q1 Investment Letter

Pernas Portfolio performed well in Q1 2023, returning 15.2%. This outperformed broad market averages, which returned between 1% and 7.5%. Attribution was largely driven by META and PTON, along with small tactical plays. During the quarter, there was high volatility in both equity and bond markets, and interestingly, we observed day-to-day correlations between the two exhibiting either highly positive or highly negative correlation. We expect this correlation to return to more normalized levels as inflation continues to moderate. However, it is difficult to determine whether the rate of moderation will be fast enough to allow the Fed to relax its tightening. We suspect that the volatility witnessed this quarter will be representative of the rest of the year.

The surprise story of the quarter was the bank panics. Some bank names sold off so violently that we found ourselves pulling late nights combing through regional bank portfolios. We ended up taking a small position in First Republic Bank (NYSE: FRC), which we held for only a day. We explained our reasoning in real-time on Twitter @pernasresearch. Despite genuine regional banking concerns that are worth monitoring, the U.S. banking system as a whole is well-capitalized and well-supported by regulators.

Cost structure increases, along with the cost of debt moving higher, contributed to an earnings season that was quite soft, with a Q/Q decline of 6.6%. After revising estimates downward, analysts are projecting earnings decreases of 4.4% for Q2 2023, but then earnings growth of 2.3% and 9.3% for Q3 2023 and Q4 2023, respectively. We continue to believe that actuals could fall well below analyst estimates, and although the majority of our investible assets will always be invested in equities, we currently have an unusually high weighting in short-term cash instruments.

Despite the equity market being down from its high-water mark in 2021, finding bargains has not been easy, and most of the names we evaluate are still trading significantly higher than their intrinsic value. Pockets of value are beginning to appear in recessionary-sensitive industries and overleveraged companies with variable debt, but it should come as no surprise that it is best for the majority of investors to steer clear of this space entirely.

Position Updates

META (NAS:META)

Following our position initiation in March 2022, we observed how popular narratives of TikTok fears, Apple ATT (app tracking transparency) changes, regulatory crackdowns, and “all in Metaverse bet” coalesced to drive a 73% sell-off in META (NAS:META). In November 2022, we increased our stake in META as the company remains one of the most profitable with sales per employee amounting to $1.4mm (pre-layoffs). We believe that META will continue to gain market share in the short video format category and continue to drive monetization in line with ‘Stories’. Although ATT is detrimental to META’s profitability in the short term to the tune of $10B, we believe it is beneficial in the long term as the ATT changes make it significantly harder for entrants to reach profitability due to the increased inefficiencies of ad targeting. The use of first-party data will continue to gain in value and META’s 3-billion user base allows them to spend more on R&D and growth capex than competitors, giving them a durable competitive advantage. Aside from growth initiatives and their competitive positioning, Zuckerberg is intent on cutting costs and has named 2023 the ‘Year of Efficiency’. Post expense management targets, META is trading at about 14x earnings (excluding Reality Labs operating expenses of $14B/year and growth capex of $12B/year). As for Reality Labs and growth capex, we believe Zuckerberg is a rational actor who will either pare back these expenses if they are not yielding returns or lean more aggressively into them if they are.

Endor (MU:E2N)

We have initiated a position in Endor (MU:E2N). E2N is a premium simulation racing brand that has been growing revenues at a 30% CAGR over the last five years. As the dominant premium brand with about 40% market share, Endor will capitalize on the rising demand as sim racing gains legitimacy with motorcar sports organizations coupled with the continuing immersion of games. Demand is still alive and well in 2023; Endor’s newly introduced entry-level racing bundle recently sold out about one week after launch. Endor is run by owner-operator Jackermeier who created the company in 1997 and who continues to execute on his vision of building out the “Apple” of sim racing equipment by stressing convenience and premium quality. We believe Endor is trading at a discount to intrinsic value of at least 30%.