Dear Partners,
McIntyre Partnerships Returns
Performance and Positioning Review – FY 2024
Through Year End 2024, McIntyre Partnerships returned approx. 2% gross and 0% net. This compares to our benchmark, the Russell 2000 Value, which returned ~8%. The fund’s trailing five-year returns are ~27% gross and ~22% net per annum, which compares to our benchmark’s return of ~7% per annum. Since inception, the fund has returned ~18% gross and ~14% net per annum, compared to our benchmark’s return of ~7% per annum.
In the winners column, CC, OSW, SWIM, SPHR and OTC:MDRX contributed 100-500bps. In the losers column, SHC, LESL, GTX, and STHO lost 100-500bps.
2024 was not a great year for the fund, and it marks the first year we have underperformed our benchmark since 2019. As a reminder, the fund’s goals are 1) an annualized 1000bps gross outperformance versus our benchmark over time and 2) outperformance in two out of three years. While we have hit these goals historically, it does not make our 2024 results any more fun to report. Continued underperformance of this sort would rapidly eat into our track record, and my sole focus is ensuring that does not happen. Having said that, beneath the surface of our measly returns are reasons for optimism, and I believe our portfolio is well situated entering 2025.
The main culprits of our underperformance were declines in several large, long-held positions, with SHC falling -24%, GTX -7%, and STHO -35%. Indeed, had I not placed a single trade in 2024, the fund would have declined ~4%. Despite the decline in these stocks, I still believe my long-term theses on these investments are correct, and I provide an update on each later in the letter. We offset the underperformance of our January 1 portfolio with good trading in SHC, where my decisions limited our loss by a few hundred basis points, two timely event driven trades in CC and MDRX, and our new investment in pools, specifically SWIM. In addition, OSW was a significant winner this year, which rallied 40%, along with SPHR which rallied 18%. Given the rallies in SPHR and OSW, I have reduced both positions. Finally, we have added two larger positions in our pool basket (SWIM, LESL, HAYW) and SEG. While these investments are new and, beyond SWIM and LESL, have not contributed much PNL in either direction, I believe they are exceptional opportunities and further strengthen my belief in the underlying portfolio.
Putting it all together, I made some good decisions and found good new ideas, but we underperformed due to declines in three large, high-conviction ideas. Given the declines in some of my top ideas, I think it is fair to question my analysis. In my opinion, the critical question is, have I made an error in my analysis, in which case I must correct the ship as quickly as possible, or have I made an error in timing, which would bode well for our portfolio? I address each name individually in the following sections, but I still firmly believe in these investments. If my analysis proves sound, I believe we will be rewarded for our patience.
While I understand it can seem trite to say, “Sorry about the miss, but our forward returns are looking even better” to a year of underperformance, I would point out that we have performed well after a down year. The last time the fund entered a downturn was 2018. Even including a significant underperformance in 2019, our forward three-year and five-year gross and net returns were 29%/24% and 26/21%, respectively. Those are obviously not guarantees of future returns, but historically, the best time to invest with me has been after a period of underperformance. I am working hard to make that the case yet again.
Portfolio Review – Exposures and Concentration
At month end, our exposures are 111% long, 13% short, and 98% net. Adjusted for our options hedges, the portfolio is approximately 94% net long. Our five largest positions are SHC, our Pool Basket (SWIM, LESL, HAYW), SEG, GTX, and STHO, and account for roughly 76% of assets.
Portfolio Review – New Positions
Pool Basket (SWIM, LESL, HAYW)
As some of our partners know, I am a long-time follower of the residential construction and building products sectors. Early in my career, I wrote a lengthy and well-timed white paper arguing that the US residential construction cycle was at a bottom, the market was showing green shoots, and numerous investment ideas stood to benefit substantially when the tide turned. I publicly posted that idea in 2011, and the stocks saw significant gains in the following years. Since that first investment, I have continuously followed the housing market and building products space, and the fund has opportunistically invested several times. However, while I believed that various single-name equities were attractively priced at specific points, I had not seen a building product reach cyclical lows like in 2011 until I started researching the pool market last year. I believe the pool market is at a level not seen since the bottom of the Great Financial Crisis (GFC). I have identified and invested in several equities I believe will benefit substantially when the market turns.
Historically, pool starts have averaged roughly 11% of single-family home starts, yet new pool starts are trending closer to 6%, the lowest attachment rate on record. While this does not definitively mean we are at a bottom, I believe it implies we are close. Several other factors, such as the ~90% decline in pool financings, overall R&R trends, and the absolute level of pool starts hovering near levels that held even when single-family starts were over 50% lower than present, give me confidence that new pool construction is unlikely to fall materially lower than current levels. Further, many pool equities were only IPOed a few years ago, thus few investors are familiar with the pool cycle. I believe this has resulted in several pool-related equities pricing in unrealistically low forward earnings expectations, which creates a significant opportunity for the fund.
Over time, new pool construction has been tightly correlated with new single-family home construction. From 1992 to 2022, pool starts and single-family home starts had a ~91% correlation coefficient.
During this period, new pool starts averaged ~11% of new single-family home starts, with a somewhat higher percentage during the go-go years of the housing bubble and a slightly lower rate in the more sober times since. While data on pool starts is limited before 1992, roughly speaking, there are 145MM homes in the United States, 55MM of which have been built since 1968, and there are 11MM pools in the country. As the mass market popularity of pools only took off after World War II, this supports my belief that pool starts should average roughly 10% of new single-family homes over time. Further, the ~58k pool starts industry groups estimate the US saw in 2024 is only a smidge above the absolute low of pool starts in the post-GFC recession. If the GFC conditions of a 20% decline in home prices, a 73% decline in single-family homes constructed, and a 10% unemployment rate did not drive pool starts below 53k, I am willing to bet the present macro environment will not either.
Finally, the decline in pools should not be analyzed in a vacuum. As previously stated, pool construction is highly correlated with new residential construction. Still, it is also broadly related to residential home improvement, existing home sales, and interest rates in general. The unexpected and sharp Fed tightening cycle that began in 2021 has negatively impacted the entire housing market. The 18-month decline in residential R&R is the longest on record, excluding the GFC, and existing home sales are back to GFC lows.
Recently some of these leading indicators have started to turn. The Fed has begun to lower rates, albeit gradually. R&R spending appears to have inflected positively in Q4 2024, and leading sources across the R&R sector are seeing early signs of a return to modest growth in 2025. Further, my checks into the pool market indicate a thawing in both R&R and new pool construction trends. If these green shoots continue, I believe pool fundamentals are near a bottom with significant upside potential as the market recovers.
Market Hedges
In general, I do not hedge the portfolio for macro reasons and instead attempt to buy stocks with a margin of safety large enough to overcome macro issues. Having said that, regardless of stock selection, we own a portfolio of assets that correlates with the broader market. We can debate what is “priced in” to our various holdings, but if the S&P 500 (SP500, SPX) is down sharply, our portfolio will likely suffer.
Recently, I have become concerned with the valuation of the broader markets, in particular the S&P 500 and its valuation versus rates. In a historical context, the S&P 500 is reaching a valuation near the highest it has ever traded.
My concern is both with the index’s absolute level and its relative valuation versus debt securities. At 22x EPS, the index is trading at a roughly 4.5% yield, which, adjusted for working capital and capex, is closer to a 3% distributable cash yield. In a vacuum, I would not feel comfortable underwriting such a small initial distributable cash yield for a broad portfolio of stocks. Further, the S&P 500 has historically struggled to hold such tight yields, with two notable bear markets occurring in the aftermath.
More importantly, I do not believe the S&P 500 is attractively priced relative to the value of its underlying bonds. Since 1960, the S&P 500 has traded around 13-17x earnings for a 6-8% earnings yield. During that time, 10-year treasury (US10Y) yields were roughly 4-7%, yielding a small equity risk premium (ERP), somewhere around 100bp.
At present, as shown in the graph at the beginning of this section, the S&P 500 is trading at a slightly negative ERP for the first time in over twenty years. However, the simple presence of a negative ERP does not in and of itself mean stocks will fall. Indeed, the S&P 500 traded at a negative ERP for most of the 1980s and 1990s bull market. The critical detail is that the index was significantly cheaper, averaging close to a 10% distributable cash flow yield, and the index did not trade greater than 15x forward earnings until the late 1990s. Indeed, from 1980 to 1995, the S&P 500 averaged 14.7% per annum, but investment grade bonds averaged 14.4%, and the 10-year treasury averaged 12.1%. Thus, it is questionable whether investors were adequately rewarded for the excess risk in this period.
Taking a step back, my fear is that the S&P 500 will revert to historical norms, and our portfolio will be caught in the crosswinds. If the ERP were to revert to its long-term 100bps average, it would imply an 18x multiple and a 20-some percent correction. For perspective, if an asset compounds at 10% for nine years and corrects 20% in year 10, it results in a 10-year 6.5% compounded annual return. Against this, I believe we own a concentrated portfolio that I estimate is cheaper than the S&P 500 with better growth trends. Over time, the accuracy of my investment theses will have a much more significant impact on our returns than any movement in the broader indices. However, we are still correlated with the S&P 500 in the short run, and given my fear of a mean reversion, I think decreasing our correlation to an event I believe is at least modestly probable is warranted.
As I did with our interest rate hedge, I want to lay out the strategy rather than delve into the specifics. First, I fully expect to lose 100% on our hedge. As such, I plan to keep our gross investment small. Second, I am targeting deeply out-of-the-money puts, which should give the hedge a strong skew. Third, my goal is to lessen the blow of a correction, not generate overall positive PNL. If the market drops 20%, I fully expect the fund to be down, just less than otherwise.
Portfolio Review – Existing Positions
Sotera Health Company (SHC)
SHC is a high-quality company where exaggerated legal liabilities and, to a lesser extent, a market downturn have presented an excellent entry multiple in my opinion. In a vacuum, SHC screens as my ideal type of business: one half of a duopoly market with good long-term growth where the product sold is mission critical to customers with high switching costs, yet the product’s price is immaterial to their customers. In the case of SHC, the company is one of two scaled outsourced medical device and pharmaceutical sterilization services providers. SHC is diversified across almost all major medical device and pharmaceutical manufacturers, boasts a 100% retention rate with top customers, and has consistently grown sales at close to 10%, albeit sales have slowed to 5% in the present downturn. Further, sterilization represents ~1-5% of their customers’ cost of goods sold, and SHC has an ~55% EBITDA margin. Normally, a consistent 10% growth story with 55% margins would trade at a significant multiple. Indeed, from when SHC IPOed in late 2020 until legal fears derailed the stock in fall 2022, shares consistently traded over 18x EV/EBITDA and 25x P/E. However, due to the market’s perception of its legal risks and end-market downturn, shares currently trade less than 10x my 2025 EV/EBITDA and 13x my 2025 EPS.
As astute partners may notice, the above paragraph is almost verbatim to our Q4 2023 letter. This is no accident – nearly nothing has changed to our business and valuation analyses. There has been no increase in competition, no change in technology, no loss of customers, etc. On the surface, SHC would appear to have had a pretty standard, albeit slow, year. Sales and EBITDA grew roughly 5%, towards the low end of their historical growth rate due to previously communicated customer destocking, and the company paid down ~5% of its debt. Despite this, shares fell 19% last year.
I attribute the decline primarily to an uptick in litigation headlines and the continued end-market downturn. Regarding litigation, in March 2024, SHC saw new litigation, this time in plaintiff-friendly California. As a “double whammy,” the legal headlines hit in the days following a busted block trade from SHC’s private equity owners, and shares fell from $17 to $11 in a month. That decline implied the market was placing an almost $2B present value on the CA litigation. While I understand many investors may be unfamiliar with mass tort litigation, I am not. I believe the decline is a significant overestimation of any probable outcome. For instance, the CA litigation’s $2B implied liability presently has 29 plaintiffs. In prior settlements, SHC paid $408MM to settle 870 cases in Illinois and $35MM to settle 79 claims in Georgia.
Regarding the stabilization of their end markets, SHC has been frank about the issues with customer destocking. They repeatedly identified the issue and gave reasonable guidance. At a recent JP Morgan Conference, SHC had the following comment:
Casey Woodring, Analyst:
Should we continue to expect this gradual volume improvement in ’25? And at what point this year would you expect volume to return to like more normalized levels as destocking hopefully abates?
Michael Petras, CEO:
Yes. I would — we’ll guide on 2025, as I mentioned, in late February. But overall, we expect a gradual improvement throughout the year on Sterigenics. We saw that. We would have expected and hoped for significantly more volume, but it didn’t play out in 2024.
But where we see ’24 finishing and into ’25, we’re confident the volumes will continue to improve based on what we know today…
Third quarter, we saw the growth over the second quarter. We would expect that to continue over time. Some of the other categories, quite honestly, we’re not having a lot of discussion around inventory destocking these days. It’s — even in the third quarter, we mentioned that on our earnings call that that hasn’t been a big topic. So I think it’s stabilizing.
For perspective, SHC grew volumes 4-7% from 2019 through 2022. As the destocking headwinds fade, I believe SHC can return to its historical EBITDA growth of ~10%. I expect the stock to reweight materially as volumes recover.
Garrett Motion (GTX)
GTX is a leading manufacturer in the moat-rich turbocharger (TB) market, with a global end-market and industry-leading margins. As TBs are not used in battery electric vehicles (BEVs), the market has concerns about GTX’s terminal value, which is suppressing its valuation. GTX trades ~5x my 2025 levered FCF with leverage at 2x EBITDA. Beyond its core business in TBs, GTX has a separate BEV growth story that is currently pre-revenue with high upfront costs, depressing GTX’s reported run-rate FCF. As a result, I believe GTX is even cheaper on owners’ earnings than the headline numbers suggest. Beyond its BEV investments, GTX has been using its FCF to buy back significant amounts of stock. Since 2022, GTX has retired almost one-third of its shares outstanding. If either BEV penetration is less bad than feared or GTX has success in its BEV investments, I believe GTX shares are significantly undervalued.
Before I dig into numbers, I want to revisit GTX’s TB business, which I believe has a deep moat and is highly predictable. TBs are a high-tech, mission-critical component of a car’s engine. The TB market is a duopoly between BWA and GTX. While there are also smaller Asian competitors, GTX and BWA enjoy significant engineering and R&D advantages over their peers, which creates a moat and allows GTX to earn among the highest margins and lowest annual price downs of any publicly traded auto supplier. TBs are essentially mini-jet engines that take the exhaust fumes and push that air back into the engine, increasing power and fuel efficiency. TBs are highly sophisticated devices – the TB’s turbine spins at up to 150,000 RPMs, yet the distance between the spinning turbine and the wall of the TB can be as small as a seventh the width of a human hair. GTX’s years of R&D allow them to deliver products that competitors cannot match. As a testament to this, Bosch and Mahle, two of the largest auto suppliers in the world, launched a TB joint venture in the late 2000s with the explicit blessing and support of GTX’s customers, the auto OEMs. A scaled competitor teaming up with your customers to break your duopoly is a business nightmare, yet after a decade, Bosch-Mahle gave up and exited the space. They could not match GTX’s products. Finally, the TB is a critical component of an engine, which is, in turn, the most important component of a car. Engines are designed years in advance, and once a product is designed into an engine, it is virtually impossible to design out. Once Mercedes designs a Garrett TB into an AMG engine, GTX has an almost guaranteed 100% renewal product with a multi-year life cycle. GTX’s backlog is exceptionally sticky and 90% booked 3+ years out. While BEV is a wild card, GTX has visibility on its core operations for years.
Regarding numbers, GTX earned ~$600MM in 2024 EBITDA with $90MM in capex, yielding $300-$350MM in levered FCF with ~200MM shares outstanding, or $1.65/sh. Further, GTX is spending ~$165MM in R&D, with over half of R&D going into zero emission vehicle (ZEV) technologies, and over 30% of GTX’s capex is also related to ZEVs. I estimate total ZEV spend is an ~$130MM drag on FCF, yielding true “owners earnings” of $2.30/sh.
Looking forward, GTX believes its ZEV expenditure will begin producing significant results in 2030. By then, GTX will have invested over $1B in ZEV. If their ZEV business can ramp up to a meager $50MM in profit over expenses by 2030, barely any success at all given the cost, it will result in a $180MM benefit to EBITDA. In contrast, of GTX’s ~$600MM in 2024 EBITDA, ~60% is generated from passenger vehicles at risk from BEV disruption, while ~40% is generated from commercial vehicles and aftermarket sales that are not presently in decline. This yields ~$360MM of “at risk” EBITDA. In 2024, BEVs were ~13% penetrated, up from 11.5% in 2023. This is a ~25% a year growth rate, a deceleration from the >50% growth rates seen two years ago. Even if BEV penetration ramps significantly above current trends and reaches 40% by 2030, I estimate it would result in a 50% reduction in GTX’s “at risk” EBITDA, or ~$180MM. Thus, even if BEV trends turn out worse than expected, it should be offset by either success and/or cost cutting in its growth strategy.
Regarding 2030 targets, GTX should generate $1.5B in FCF by 2030. Assuming GTX pays off $500MM in debt and buys back $1B in stock, GTX will have about $800MM in debt with 100MM shares outstanding at current prices. If EBITDA can hold flat, GTX should earn ~$3.50 in 2030 FCF/sh. If BEV is only 30% penetrated in 2030, it would add about $90MM to my estimates, or 70 cents a share after taxes. If GTX’s growth investments are successful, the company estimates at least $100MM in profits, or 80 cents per share post-tax. If both scenarios play out, by 2030, GTX will be generating $5 in FCF/sh.
Taking a step back, I think a slower-than-feared ramp in BEV and modest success in ZEVs are more likely than not. However, to our fund’s benefit, I think GTX is unlikely to stay at the current prices as those events unfold, and my buyback assumptions are likely too aggressive. I believe it is probable that at some point in the next three years, if BEV continues to decelerate and/or GTX shows successful ZEV wins, GTX shares can reweight towards other legacy auto suppliers, such as PHIN, which trades 10x 2025 EPS. A 10x multiple on my 2025 estimates yields a $17 price target.
Star Holdings (STHO)
STHO is an illiquid security whose business plan is to liquidate over time. The thesis is simple: as STHO’s assets are sold off, STHO will dividend the profits and converge towards its NAV. At present, I calculate STHO’s NAV at $28 versus its current $9 trading price. I believe the liquidation will take four years, which results in a 33% IRR. While I believe there is a good probability STHO will dividend some of the proceeds along the way, I assume a bullet payment in four years for simplicity and conservatism.
STHO has two significant assets: 13.5MM shares of SAFE, a publicly traded REIT, and some legacy real estate investments with a net book value of $180MM. SAFE presently trades at $16, which, given that STHO has 13.3MM shares outstanding and an $87MM margin loan collateralized by the position, yields $10 in value per STHO share. Adding the $14 book value per share of STHO’s other assets would yield a $24 NAV. However, I believe this undervalues STHO, perhaps significantly. The liquidating real estate’s largest asset is its investment in Asbury Park, a growing beach town in New Jersey. The Asbury Park real estate has a book value of $133MM, of which $70MM is two hotels and an entertainment space currently marked at a cost of $90MM minus $20MM of accumulated depreciation. In contrast to these conservative marks, STHO’s Asbury Park investments are thriving, with hotel rooms going for $600-$1000 a night during the >90% occupancy summer season. Another $67MM is ~30 acres of beachfront land, a mark which I believe will prove conservative should Asbury Park continue to grow. For simplicity, I assume STHO’s real estate is worth an additional $50MM, yielding $18/sh.
While it may take a few years, I believe STHO offers a compelling IRR. Further, SAFE is particularly rate sensitive. Should long-term rates fall, I believe my NAV has significant upside. When the 10-year traded sub 4% in September 2024, SAFE shares traded as high as $28 a share, implying a $40 NAV.
On AI, Simplicity, and My Strategy
“Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count. If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you had correctly analyzed an investment alternative characterized by many constantly shifting and complex variables.” – Warren Buffett, 1994 Berkshire Hathaway Chairman’s Letter
“Markets have a way of separating egos from their money.” – George Soros
One of my favorite investment sayings is that there are no extra points for difficulty. That philosophy is at the core of my investment strategy. To paraphrase Buffett again, I am not looking to outsmart everyone and jump over a ten-foot hurdle. I am looking in less followed places for a few one-foot-tall hurdles that pay out like the ten-footers. This brings me to AI and its stock beneficiaries, the latest “hot space” in the market over the last two years. Last week, a Chinese company called DeepSeek published a model and white paper that some argue could upend the current AI paradigm. As with many rapidly changing, cutting-edge technologies, you can find credible experts arguing both sides. I have no idea who is correct, but I can tell you I think it is hard to have confidence in either direction.
Bringing things back to investment strategy, I think it is unlikely that frequently investing in situations where credible experts differ widely will result in long-term investment success, particularly if a given investment’s risk/reward is not significantly skewed. The market is just too competitive. Instead of looking for battlegrounds in widely debated stocks, I favor investments in less followed areas where something odd presently discourages enough people from investing. For instance, I do not think our thesis on the pool market is particularly contentious or complicated. I think people are simply less familiar with the space and uncomfortable investing when trailing results have been poor, particularly given some of our pool basket’s lower liquidity.
I believe my strategy of looking for investments in less followed spaces has been a key driver of our outperformance. I intend to keep investing in this manner, even if this results in a slower pace of asset growth, a subject I address in the next section. One of the firm’s founding principles is “we cannot outperform without being different.” Another is “investors come first.” I will always place the needs of current partners above my own and any prospective future clients.
Business Updates
On the business side, the fund successfully launched our offshore vehicle in 2024 and continued to expand our investor base. We are looking to hire on the operations/investor relations side. Our audit is underway, and we plan to distribute K1s in the coming weeks.
Finally, our portfolio is presently on the lower end of the liquidity spectrum. Our ability to add to the existing portfolio is limited. As a result, I will be closing the fund for the foreseeable future after a limited funding round over the next few months. Existing LPs will have first priority and we have several commitments already. We will potentially take a limited amount of capital from new LPs.
As always, please feel free to contact me with any questions.
Sincerely,
Chris McIntyre
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