Jake Miller has perenially topped SumZero's rankings lists, taking the top spots across several categories for years. Across 20 ideas submitted to SumZero's research database, Miller has achieved an enviable 22% median and 14.52% mean return. Miller is an analyst at New York based DS Advisors, a family office. His SumZero ideas run the gamut from shorts to longs, and equity to credit. Kevin Harris from SumZero sat down with Miller to discuss his investment philosophy, background, and most recent SumZero idea.
Kevin Harris, SumZero: You’re currently the top-ranked SumZero member of All-Time, and have topped our Short, North America, Small-Cap rankings. Tell us about your background.
Jake Miller, DS Advisors: After undergrad I did a two-year banking analyst program followed by two years of sell-side research at firm that was then called SG Cowen. At Cowen, I was lucky to work under a great mentor named Paul Westra who unfortunately for all recently left to work in industry.
After Cowen, I attended Columbia Business School where I participated in the Applied Value Investing program. The program was fanatic and I was fortunate to have many wonderful professors including Joel Greenblatt, Michael Mauboussin, Paul Sonkin, Eddie Ramsden, David Greenspan and the legendary Bruce Greenwald.
I’ve been working at DS Advisors on an internal long/short fund that is part of a larger family office for about 7 years.
Harris: What soft skills do you think are important in active management?
Miller: This can be a tough business and I find it helps to have a sense of humor. Being in charge for other people’s money is heavy responsibility that requires significant trust. But that doesn’t mean you have to wear a bow tie and go around quoting Warren Buffet all day. I think it’s possible to take your work seriously, without being a ‘serious’ person.
Harris: How would you describe your investing philosophy and process?
Miller: All investments are based on a fundamental assessment of absolute, intrinsic value. This likely reflects the influence the Applied Value Investing program. I’m looking for securities that are cheap, not securities where I think I can predict a change in the price. When it’s called for we will do fairly deep, proprietary industry research and seek out non-traditional data points. We also look closely at management skill / incentives. However, all our work is intended to be in service of an appraisal of intrinsic value. Quite often I see pitches that are incredibly knowledgeable and detailed but fail to explain why a stock is cheap. To me this is worse than a bad idea, it’s not really even an idea at all.
We are also long-term investors and don’t try guess precisely when an investment will move in our favor. We’ve found that it’s hard enough knowing if you’re right, knowing both if you’re right and when you’ll be right can be nearly impossible in many situations. If you try to get too precise on timing you will miss a lot of good investments.
Harris: Can you give us an example?
Miller: We recently posted a short thesis on ArcBest. Core to the thesis is that ArcBest is a low-quality business that is over-earning due to the incredibly tight trucking market. The pushback we’ve gotten is “can’t the trucking market keep getting even better?” Of course, the trucking market can get better and if this happens ArcBest stock will likely go up. However, when we spoke to people who have been in the industry for a long time, they told us that this is the best trucking market they’ve ever seen. Not in the best in the last 10 or 15 years, but ever. As such, it would seem that one can have high conviction that normalized earnings for a cyclical business like this are materially lower than the current earnings. When this happens the stock will trade lower, but you have to be willing to accept that you can’t know when the top will occur.
Sometimes it’s important to distinguish between a good investment and a good pitch. A good pitch goes like “here’s this clever thing I figured out that most people don’t understand.” These situations can be great and will get a lot of attention from other investors, but they’re also hard to find and hard to be right about. Someone could say “XZY is a good business at good price with limited downside” and that may be a great investment, but it doesn’t make for a sexy pitch. People seem to prefer investment ideas that make them sound smart, but things that sound smart in a pitch and even things that are very smart are not necessarily the best investments available.
Harris: You’ve posted a lot of shorts over the years. How did you get into shorting? What role do shorts play in your portfolio?
Miller: I joined the rugby team in business school. Since I no longer regularly get tackled by large men trying to hurt me, I short stocks to get that same feeling.
For DS Advisors, shorts are not a ‘hedge’ – we short to make money, not to make ‘alpha’. Even in the current market we’ve largely done this. There are two things that have been critical to our short performance: First, there is no requirement we have any shorts at all. As such, we only short when we can find good shorts. Right now we have fairly robust short book, but a few years ago we had hardly any shorts. Second, we’ve been very thoughtful and deliberate in how we short. Internally, we’ve broken our shorts down into six categories based on the nature of the thesis and regularly review everything we do with the goal of learning how to become better investors. We’ve also done well shorting some fairly boring businesses and largely avoiding the ‘battleground’ names.
Harris: You’ve pitched two shorts, Skechers and Altisource Asset Management, that are now closed but at one point were up over 100% from where you pitched them. How did you handle this and how do you manage downside risk?
Miller: Despite the large temporary losses, I never felt pressed to cover these positions. Most shorts are 3-4% positions which is a size that allows us to ride out the volatility. I’m very fortunate to invest alongside my colleague Marina and the family we work for who really understand markets and have a deep trust in what we do. Of course it was painful and I naturally started second-guessing myself, but I kept updating my work and did not feel like the facts had changed. One of the hardest things psychologically as an investor is deciding whether you’re wrong or if the market has simply moved against you. In these instances we made the right decision and had a profit on Altisource and a modest loss Skechers. This would not have been possible without the trust and guidance of the incredibly high-quality people I work with.
Altisource was interesting because a lot of smart people were placing jockey bets on the CEO, Bill Erbey. Clearly having a smart and incentivized CEO can be hugely important. However, for Altisource the numbers simply never worked. A great CEO cannot fundamentally change the underlying economics of a business.
Harris: Could you walk us through your recent thesis on Alliance One (AOI)? Do you do a lot of credit investing?
Miller: We love distressed credit at the right part of the cycle and will even get actively involved in bankruptcy cases. There hasn’t been much to do on the distressed side for a few years, but we like these AOI second-lien bonds now.
AOI is half of a duopoly that controls around 80% of the non-vertically integrated tobacco market. Without getting too detailed, there are two primary reasons this business exists and is unlikely to be disintermediated. The first reason is the extensive logistical infrastructure required to buy crops from thousands of small farmers in remote parts of the world. The second reason is that by buying harvests from many farmers and selling to diversified group of buyers AOI creates a clearinghouse for different types / grades of tobacco which allows customers to create the unique blends their product’s need.
AOI has a long history of consistent cash flows. While results can vary in any given year due to harvest conditions, you can have fairly high conviction in a range of normalized earnings. At market prices you’re getting a greater-than 13% yield to maturity. The bonds are levered about 7x on current / normalized numbers but AOI requires minimal ongoing capex or taxes and as such generates significant cash flow. We calculate that AOI could afford to pay a nearly 12% interest rate on new debt when the current debt matures. Furthermore, AOI has nearly $1B in working capital which should attract interest from asset-based lenders. As such, we think AOI will be able to refi with and ABL and term loan prior to maturity.
Thinking about possible downside, even in a stress case there’s only about four turns of debt ahead of you so the 2nd lien would be the fulcrum in almost any scenario. If you had to take equity in a restructuring, in this stressed case the equity would still have a 12% cash flow yield. Given that most of the working capital is ‘committed’ inventory – meaning a large tobacco company has already agreed to purchase the inventory even in a liquidation there would be a significant recovery and impairment would likely be minimal.
Harris: Unlike many top-ranked SumZero members, you have an extremely broad circle of competence, with extremely well performing shorts and longs across a wide diversity of sectors, geographies, and market caps. Would you describe yourself as a generalist?
Miller: I would say that is accurate.
Harris: What role do online research tools like SumZero play in your research process?
Miller: T.S. Elliott said “Immature poets imitate; mature poets steal” – I think you could say the same thing about investors. If someone smart pitches you a great investment, it’d seem foolish not to use that. You don’t make less money because its someone else’s idea.
Last year, Luis Sanchez posted a short to SumZero on Genie Energy (GNE). The thesis seemed convincing and when we looked into it everything Luis had written up checked out. This one ended up playing out exactly as Luis said it would and we had a nice profit.
More recently, Chris McIntyre posted a compelling pitch on Spirit MTA REIT (SMTA). We looked into it and have been buying the stock. There are a lot of fantastic investors on SunZero, including Avi Drori, Saidal Mohmand and Kyle Mowery at GrizzlyRock, Peter Rabover, Tarak Kadia, and the folks at Union Square Park are all worth reading.
One of the advantages you have as a generalist is the ability to look at a lot of things. SumZero helps me see a lot of different ideas. I also just enjoy talking stocks and SumZero is a great place for that
Harris: Are there any names you currently like that you haven’t posted on SumZero?
Sure – it’s a bit illiquid, but I think it’s pretty compelling. The company is called Pinnacle Renewable Holdings and it trades in Canada under the ticker PL. These guys take byproducts of lumber processing (sawdust and wood shavings) and produce biomass fuel for utilities. Biomass is a renewable and carbon neutral energy source that is suitable for baseload generation and can be used by converted coal plants thus requiring minimal new infrastructure.
PL trades at about 9x 2019 cash flow (11x if you exclude the tax assets that expire in a couple years) with 2.5x leverage. 100% of current production capacity and the majority of associated costs are contracted with high-quality counterparties through 2026. These contracts provide for annual escalators, creating a predictable, growing earnings stream. At a 9% cost of capital the cash flow from the company’s current assets alone are worth about $20/share vs a stock price of about $15.60.
The biomass market is expected to grow from 12.9 million tons in 2016 to 29 million in 2021. Pinnacle is one of only two companies able to cost effectively supply new utility demand. Capacity growth creates significant value for Pinnacle. Pinnacle will only build a new plant if they have a long-term contract for the new volume. The company’s last 3 new projects have all been built at about 4.5-5x EBITDA. With 55% debt financing this implies an ROE of about 23%. Exactly, how much new capacity Pinnacle will build is hard to say, but conservatively growth should add another $6 - $10 per share and possibly much more.
The key risks are change in the regulatory structure, particularly in the UK where current subsidies need to be renewed after 2027. Also, better utility-scale battery technology could allow wind and solar to compete with biomass for baseload generation. However, given the contracted nature of the business and where Pinnacle sits on the industry costs curve, a significant impairment appears unlikely.
Harris: Since you’ve posted a lot of shorts, is it fair to assume you have a bearish macro disposition? Where do you see potential trouble today?
Miller: It seems pretty clear to me that right now the economy is doing great and stocks are expensive. There’s not really much debate about that. You can credibly say that the economy will get even better or that stocks are only kind of expensive, but you can’t credibly argue that we are in anything remotely resembling a distressed environment. With that backdrop, it seems likely that expected returns today are low. This doesn’t mean that the economic system is broken and we’ll all be eating cat food or that the Fed is poisoning our drinking water with QE, just that we are probably closer to the end of the cycle than to the beginning.
While everyone seems presently focused on tech, some of the worst valuations I see are actually in smaller cap names. There are a lot of average quality, cyclical businesses in the Russell 2000 that are trading at prices that appear very hard to justify.
Harris: Your mean total return across your SumZero ideas is 15.55%, (Median 26.59%). What do you think makes someone a good investor?
I like to use golf an analogy to investing. Just because someone is good at golf doesn’t mean they’re good at anything else. A terrible athlete who works hard on their swing with a good coach will always beat a great athlete who plays casually. Where you went to school doesn’t make you a good investor. Being a chess grandmaster, a former navy seal, being born rich or poor, being a physics PhD or a competitive triathlete doesn’t guarantee you’ll be a successful investor. Being analytical can be a small help at times as can being naturally relaxed and skeptical. However, ultimately being a good investor is the only thing makes you a good investor. What I mean by that is investing (and business in general) is a unique skill that doesn’t translate to much else. You’ve got to commit to learning the craft and finding what works for your individual temperament and interests