Discussion of markets and holdings
March 15, 2021
Dear Unitholders of Chou RRSP Fund (Trades, Portfolio),
The net asset value per unit (“NAVPU”) of a Series A unit of Chou RRSP Fund (Trades, Portfolio) at December 31, 2020 was $25.87 compared to $22.79 at December 31, 2019, an increase of 13.5%; during the same period, the S&P/TSX Total Return Index increased 5.6% in Canadian dollars. In U.S. dollars, a Series A unit of Chou RRSP Fund (Trades, Portfolio) was up 15.8% while the S&P/TSX Total Return Index increased 7.3%.
The table shows our 1-year, 3-year, 5-year, 10-year, 15-year and 20-year annual compound rates of return.
|December 31, 2020 (Series A)||1 Year||3 Years||5 Years||10 Years||15 Years||20 Years|
|Chou RRSP Fund (Trades, Portfolio) ($CAN)||13.5%||-4.6%||0.4%||2.8%||2.3%||6.0%|
|Chou RRSP Fund (Trades, Portfolio) ($US)1||15.8%||-5.0%||2.1%||0.2%||1.7%||6.8%|
Rates of return are historical total returns that include changes in unit prices, and assume the reinvestment of all distributions. These annual compounded returns do not take into account any sales charges, redemption fees, other optional expenses or income taxes that you have to pay and that could reduce these returns. The returns are not guaranteed. The Fund’s past performance does not necessarily indicate future performance. The table is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values of the mutual funds or returns on the mutual funds. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing.
Factors Influencing the 2020 Results
The equity holdings of Overstock.com Inc., Interfor Corporation, Resolute Forest Products Inc., TVA Group, Linamar Corporation, Magna International Inc. and TWC Enterprises Ltd. contributed positively to the Fund’s performance during the year.
The main negative contributors to the Fund’s performance in 2020 were the equity holdings of Reitmans (Canada) Ltd., Bausch Health Companies, WOW Unlimited Inc., Bank of America Corporation and EXCO Resources Inc.
During the period, the Fund reduced its holdings of EXCO Resources Inc., Bank of America Corporation, Bausch Health Companies, Overstock.com Inc., TVA Group and Blackberry Ltd.
The Fund sold holdings in Fairfax Financial Holdings and Torstar Corporation in 2020. As of December 31, 2020, the Fund had four covered call options on Blackberry Ltd. and Resolute Forest Products.
Resolute Forest Products (NYSE:RFP) (“RFP”)
As of December 31, 2020, the market price of RFP was US$6.54 per share, up 55.7% from the price of US$4.20 at year end 2019. In spite of that, RFP has been a huge disappointment since our initial purchase some eight years ago. It shows how tough it is to turn around a troubled company despite the best efforts of management. Having said that, it is quite comical to experience how a commodity stock can be hammered beyond all logical comprehension. RFP paid a special dividend of US$1.50 a share in 2018, and it was trading as low as US$1.17 per share in April 2020. Back in March 2020, the company announced that it would buy back 15% of its common shares for US$100 million. At the lowest year-to-date price of US$1.17, the whole market capitalization would be approximately US$99 million. In other words, instead of buying back 15% of the company with US$100 million, it could repurchase 100% of the company at one point. RFP shares have since recovered 459% to US$6.54 at year-end. Patience has been rewarded.
One bright spot for the company has been its lumber operations. The high prices for lumber should make up for the declines in its newsprint and specialty papers business segments. The COVID-19 pandemic has shifted management’s focus more towards its lumber/pulp/tissue operations and we believe that should generate greater cash flow in the future.
In general, our experience with a commodity business that has virtually no pricing power is to be cautious when management talks about investing in new equipment or upgrades that would significantly lower the cost structure compared to its competitors. That may be true for six months to a couple of years, but in time, competitors will have a new cost structure that is as competitive if not superior to the company. It is the same treadmill where hardly anyone in the industry can make a decent return on the assets invested in the company. The same story can be seen repeatedly in various commoditized industries. There is no sustainable long-term advantage in a mediocre business with no pricing power. It is important not to get seduced by discount to book value. If the company cannot generate a decent return on book value over a long period of time, that book value is not worth much.
Bausch Health Companies Inc. (NYSE:BHC) (“Bausch Health”)
In early August 2020, Bausch Health announced that it is planning to spin off its eye care business, Bausch + Lomb, into an independent publicly traded company. This will allow the company to concentrate on its gastroenterology, aesthetics/dermatology, neurology and international pharma business.
Chairman and CEO Joseph Papa said, “We’ve looked at the value of our pure health companies like Alcon and Cooper and believe that Bausch + Lomb would compare very favorably when investors have an opportunity to make a judgment about the relative value of the stand-alone business”.
Comparable companies like Cooper Companies and Alcon Inc. are currently trading between 18 and 20 times 2022 EBITDA estimates and 25-30 times trailing EBITDA estimates. If Bausch + Lomb trades at similar multiples as a stand-alone company, the total value of Bausch Health using sum-of-the-parts method would be worth north of US$45 per share (net of debt). We felt that Bausch was undervalued for a long time, but investors were not giving credit that management has done a good job in running the operations, selling non-core assets, as well as de-leveraging its balance sheet. They felt the process was too slow. We hope the spin-off of Bausch + Lomb unit will be the catalyst that is needed for investors to price the company closer to its intrinsic value.
EXCO Resources Inc. (EXCE) (“EXCO”)
In early July of 2019, the company emerged from bankruptcy and the 1.75 lien term loans were converted into 28.38 equity shares for every US$1,000 in par value, after netting out certain adjustments. We received 357,285 shares of EXCO in the Fund. The equivalent price is US$9.51 per share of EXCO.
Looking back on this investment, we underestimated how long the price of natural gas would stay low for and how low it has been relative to the price of oil. Historically, there had been a strong relationship between the prices of oil and natural gas. Thinking about the two fuels in terms of energy equivalency, 6,000 cubic feet (6 mcf) of natural gas has the same amount of energy content as 1 barrel of oil. In the past, this 6 to 1 ratio guided the relationship between oil and natural gas prices but for the last few years the ratio between prices has gone up to as high as 50 to 1.
Long story short, it was not such a great idea in investing in the 1.75 lien term loans of EXCO.
During the year ended December 31, 2020, an affiliate of the Manager purchased 242,914 units of EXCO shares from the Fund to reduce the Fund’s exposure to illiquid securities. The security was sold for $3,153,029, which was deemed to be the fair market value at the time of the trade as determined by an independent pricing company. This related party transaction was approved by the Independent Review Committee and received exemption relief from the Ontario Securities Commission to record a trade transaction with an affiliate. As at December 31, 2020, EXCO comprised 3.2% of the net assets of the Fund.
Caution to the Investors
Investors should be advised that we run a highly focused portfolio, frequently just three to five securities may comprise more than 50% of the assets of the Fund. In addition, the Fund has securities that are non-U.S. and could be subjected to geopolitical risks, which may trump or at least negatively influence the financial performance of the company. Also, we may enter into some derivative contracts, such as credit default swaps when we feel that the market conditions are right to use those instruments. Because of any or all of these factors, the net asset value of the Fund can be from time to time more volatile than at other times. However, we are not bothered by this volatility because our focus has always been, and continues to be, on how inexpensive we believe the Fund’s portfolio holdings are relative to what we believe to be their intrinsic value.
The Fund’s net cash position was approximately 1.3% of net assets as at December 31, 2020.
FOREIGN CURRENCY CONTRACTS: None existed at December 31, 2020.
CREDIT DEFAULT SWAPS: None existed at December 31, 2020.
U.S. DOLLAR VALUATION: Any investor who wishes to purchase the Chou Funds in U.S.
dollars may do so.
REDEMPTION FEE: We have a redemption fee of 2% if unitholders redeem their units in less than 3 months. None of this fee goes to the Fund Manager. It is put back into the Fund for the benefit of the remaining unitholders.
INDEPENDENT REVIEW COMMITTEE: The Manager has established an IRC as required by NI 81-107. The members of the IRC are Sandford Borins, Peter Gregoire and Joe Tortolano. The 2020 IRC Annual Report is available on our website www.choufunds.com.
As of March 15, 2021, the NAVPU of a Series A unit of the Fund was $33.66 and the cash position was approximately 2.9% of net assets. The Fund is up 30.1% from the beginning of the year. In U.S. dollars, it is up 32.7%.
Except for the performance numbers of the Chou RRSP Fund (Trades, Portfolio), this letter contains estimates and opinions of the Fund Manager and is not intended to be a forecast of future events, a guarantee of future returns or investment advice. Any recommendations contained or implied herein may not be suitable for all investors.
- The alternative method of purchasing Chou RRSP Fund (Trades, Portfolio) in $US has been offered since September 2005. Performance for years prior to September 2005 is based on the $US equivalent conversion of the results of the Chou RRSP Fund (Trades, Portfolio) ($CAN). The investments in the Chou RRSP Fund (Trades, Portfolio) ($CAN) are the same as the investments in Chou RRSP Fund (Trades, Portfolio) ($US) except for the currency applied.