Value Investing Q4 Letter Recaps: ROST, EW, SPOT

Our Value Investing Letter Recaps keep things simple. 

Each email focuses on three value investing hedge fund letters, three ideas, all digestible in roughly three minutes

Within each idea we answer four main questions: 

  • What does the business do? 
  • Why is it a good bet? 
  • Why does the opportunity exist? 
  • What is the prize if you’re right?

Quick housekeeping note that nothing you read is investment advice and please do your own due diligence before investing. Also, I do not own any of the below-mentioned securities as of this writing. 

Finally, we get each investment letter from r/SecurityAnalysis, which you can find here

This week we analyzed Ross Stores (ROST), Edwards Lifesciences (EW), and Spotify (SPOT).

Let’s get after it. 

Top 3 Value Investing Letters You Need To Know About

1. Right Tail Capital: Ross Stores (ROST)

Jeremy Kokemar is a routine guest on our Value Letter Recap series. You can listen to my podcast with Jeremy to learn more about his investment philosophy/process. 

This quarter, Jeremy highlights his latest long idea, Ross Stores (ROST). Check out his Q4 letter here

Let’s dive in.

What does ROST do? 

“Ross Stores delights its customers with a treasure hunt experience. The company has ~2000 off-price retail stores around the country. Ross’ name-brand apparel and home fashions offer savings of 20% to 60% relative to typical retail prices.” 

Why is it a good bet? 

“Ross provides value to several of its partners. Customers, who either want a bargain or possibly need a bargain, discover less expensive branded goods. Vendors rely on Ross to sell unwanted inventory discreetly. Rather than discounting the product at their own stores or website and training customers to expect and even wait for discounts, a vendor sells some of its product to Ross, receives cash for its inventory and can move on. 

Interestingly, Ross’ value proposition likely increases during tougher economic environments like the one we’re in today and the great financial crisis. Consumers know they can find a good deal. Vendors liquidate unwanted inventory and plan for the next selling season.”

Why does the opportunity exist? 

“The opportunity to invest in Ross at a discount to intrinsic value likely exists for a few reasons. There are general worries about the health of the economy, stock market and consumers. Recent same store sales have been down low to mid-single digits after a strong 2021. These concerns also ignore that same store sales have increased low to mid-single digits over the last two decades. 

Additionally, Ross has faced margin pressures due to labor shortages and freight challenges, the latter of which continue to abate. It’s been a unique, challenging set of circumstances the last few years between Covid, stimulus and cost pressures that have affected all parts of Ross’ and its off-price competitors’ businesses.”

What is the prize if you’re right? 

“In a typical year, Ross likely grows earnings in the low double digits or higher. They achieve this through same store sales and new stores each growing low to mid-single digits. From this base of 5-8% revenue growth, the company achieves some operating leverage and shrinks the share count to get to low double-digit earnings growth. 

The opportunity today is potentially sweetened assuming Ross can improve margins back to pre-pandemic levels. Combine it all and a mid-teens CAGR or 5-year double seems like a reasonable base case from today’s prices.”

Further Research Material

2. Wedgewood Partners: Edwards Lifesciences (EW)

Wedgewood Partners always releases high-quality, long-form quarterly letters. You can read their latest one here.

Three men run the partnership: David Rolfe, Michael Quigley, and Chris Jersan. 

This quarter we profile one of their long-term holdings: Edwards Lifesciences (EW).

What does EW do?

“The Company is a leader in treating structural heart diseases and providing critical care technologies to surgical and intensive care centers. Edwards’ flagship franchise is its Transcatheter Aortic Valve Replacement (TAVR) SAPIEN family of aortic heart valves.” 

Why is it a good bet? 

“The good news about Edwards’ treatable population is they are living longer, not only once they reach 70 years of age but also once they reach 80 years, and beyond. As people are living longer, they are more susceptible to moderate and severe forms of aortic stenosis. So there’s no shortage of patients in need of TAVR treatment. 

However, as we mentioned earlier, often the bottleneck to treatment is administrative rather than clinical. For example, less than a quarter of 80-year-old patients who have been diagnosed with SAS actually get referred to treatment – that’s over 200,000 elderly patients in the U.S. who are not getting treatment.”

Why does the opportunity exist? 

“As we have noted in the past, the demise of TAVR growth has been written about every few years. Given the recent bottlenecks in the U.S. healthcare system, those calls for gloom and doom are coming again. But as we can see, the untreated population for both severe and moderate aortic stenosis is clearly huge and underserved, so TAVR’s demise continues to be greatly exaggerated.”

What’s the prize if you’re right? 

“We expect Edwards to be able to compound revenues at a double-digit rate over the next several years by driving higher adoption of TAVR as well as through the launch of new platforms targeting other forms of structural heart disease (especially related to mitral valve). The Company probably “under-earns” as they commit between 15-20% of revenues to R&D, a multiple of larger med-tech conglomerates (e.g. Medtronic, Abbott Laboratories, and Stryker).” 

Further Research Material 

3. Rowan Capital: Spotify (SPOT)

Rowan Capital is a two-man investment partnership investing primarily in high-growth/technology companies. The partnership returned -61% in 2022. Despite its drawdown, I enjoyed their Q4 letter, which you can read here

This quarter, Rowan Capital dissects the “extreme mispricing” in SPOT’s stock price. 

What does SPOT do? 

Via SPOT provides audio streaming services worldwide. It operates through Premium and Ad-Supported segments. The Premium segment offers unlimited online and offline streaming access to its catalog of music and podcasts without commercial breaks to its subscribers. The Ad-Supported segment provides on-demand online access to its catalog of music and unlimited online access to the catalog of podcasts to its subscribers on their computers, tablets, and compatible mobile devices.

Why is it a good bet? 

“Spotify is estimated to end 2022 with 479 million monthly subscribers.  Management thinks that their subscribers can get 1 billion over the next 4-5 years.  The paid subscribers are estimated to end 2022 at 202 million.  Therefore, based on today’s price, we are paying only $74 per paid subscriber.  Now, let’s assume that Spotify can get to only 5 euros in ARPU (they are at 4.63 euros currently), then they would be collecting 60 euros per paid subscriber over a 12 months period, which makes our current payback period of only 1.2 years.

This sounds like a once in a lifetime kind of deal for a very high quality brand and a unique audio platform that is still early in its growth stages.”

Why does the opportunity exist? 

“In the case of a digital platform business like Spotify, they reinvest into their future growth through Research & Development (R&D) and Sales & Marketing (S&M) expenses. R&D runs at about 10% of Sales and S&M expense runs at about 12% of Sales.  When you have a business that earns about 26% gross margins (management’s long term goal is 30-40%), these expenses can make you appear as they do not have a profitable business model — which is exactly how Mr. Market currently views Spotify.”

What is the prize if you’re right? 

“In 4-5 years, this business alone could be worth the current market cap of $15 billion.  We estimate that the premium revenues could top 20 billion euros over the next 4-5 years (assuming they can grow premium subs to 338 million and increase ARPU to 5.5 euros).  

If we placed just a 2x sales multiple on this business earning close to 30% gross margins, which we believe it deserves, then the entire company should be worth close to 60 billion euros in 4-5 years time, and we believe this number could prove to be very conservative. That is a 4X return from the current price over the next 4-5 years (30%+ IRR).”

Further Research Material

Wrapping Up This Week’s Value Investing Letters: What To Read Next

Thanks for reading, and I hope you learned something. If you enjoy this series, let me know by shooting an email or retweeting on Twitter. 

Also, please let me know if there’s an investor letter I should read that I didn’t cover here.

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Brandon Beylo

Value Investor

Brandon has been a professional investor focusing on value for over 13 years, spending his time in small to micro-cap companies, spin-offs, SPACs, and deep value liquidation situations. Over time, he’s developed a deeper understanding for what deep-value investing actually means, and refined his philosophy to include any business trading at a wild discount to what he thinks its worth in 3-5 years.

Brandon has a tenacious passion for investing, broad-based learning, and business. He previously worked for several leading investment firms before joining the team at Macro Ops. He lives by the famous Munger mantra of trying to get a little smarter each day.


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