SA Interview: High Conviction And Under The Radar Ideas With Valkyrie Trading Society

Feature interview

Valkyrie Trading Society is a long only international investor focused on developed markets, high conviction and under the radar equity ideas. On Seeking Alpha their coverage is broad, but they generate and discuss their high conviction portfolio ideas on their marketplace, The Value Lab. We discussed working from first principles to help find market inefficiencies, how to find moats and barriers to entry, and the opportunities in non-U.S. markets.

Seeking Alpha: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?

Valkyrie Trading Society: What we cover and what we buy are very different sets since we have a very concentrated portfolio of 10 stocks or less but cover hundreds of equities. Ideas chosen for the portfolio will be in markets that are not heavily covered by equity research, or are for structural reasons not as investable for the large quasi-indexers. So if a stock is being discussed in any high-visibility channel, or anyone important has made their positions known, the stock is rejected as we’d have no edge in the trade. We also don’t go higher than the mid-cap space to beat out the big funds that have large-cap mandates.

SA: Is it at this point that you start to think about limiting risks? Give an example.

Valkyrie Trading Society: Yes, that’s exactly what comes next. We look for any high leverage forces that could hurt the value of our capital. For example, if they’re doing something that has become fashionable for government crackdown, the stock is rejected. If the business is in secular decline and there are no emerging mitigating factors, the idea is rejected. If there is disruption risk from anything that benefits from network effects, the idea is rejected, because network effects are systematically underestimated.

Then we determine the upside following a very standard valuation process trying to find suitable comps to the idea, or use absolute measures of value like FCF yield, earnings yield and very rarely DCF. It’s at this point that we start to consider how attractive the economics are as well.

The last part of the process is to get realistic about how likely the upside will be realized, which is a big consideration for unknown ideas.

The lowest threshold for being able to provide returns is when there’s a high probability of earnings growth, which is an easy catalyst and gets you intermediate return while you hope for a multiple revaluation. E&P stock Japan Petroleum Exploration (OTCPK:JPTXF) was such an idea as speculation in 2022 around higher oil and gas prices would bring the stock value up with it, eventually performing well enough to get noticed and to be additionally revalued to multiples more similar to peers and close some of the gap caused by a large balance of non-operating assets, although it’s still discounted. One of our best performing ideas that we invested in heavily was Matthews International (MATW), and a clear EV angle in their industrial business that was completely disregarded because it was buried under some other businesses made earnings growth essentially certain at a low price.

Even better is when there are high dividends or buybacks, which are very relieving to see and allow you to go for especially unknown and sometimes quite illiquid ideas with confidence about the capital return. No one needs to agree with your valuation as long as there’s comprehensive capital payout. Coupled with earnings growth is better, as well as a reasonable hope that payouts could also improve. DDH1 (OTCPK:DDHLF) has been such an idea where buybacks have been in the double digits, and there’s a very ample dividend at 5% with low payouts on consistent, infrastructural earnings growth related to deposit sample drilling for helping mines decide on mine expansion plans – no major exploration risk either here.

Next in the hierarchy is where there is a possibility of activist involvement or some action by minority-stake growth equity. This puts a value on the company that markets typically don’t deny. Here you want to think like a minority-stake PE about bolt-on logic or like an activist about spin-offs and carve-outs to see if there’s a possibility of this sort of value creation. You also have to consider whether these sorts of funds even work in those markets and whether this is a catalyst you can expect.

Finally, the acquisition exit is the best thing you can get, as it should come with an additional premium for control since the company is acquired fully. At the moment this sort of exit is unlikely due to the state of financial sponsor activity, which is a big portfolio theme for us. The collapse of the LevFin markets and then overinvestment in 2021 has made them very trigger-shy.

In the end it’s nothing genius: it’s a framework that accomplishes the typical 1) don’t lose money, 2) don’t panic, 3) don’t follow the crowd system that successful investors use in some shape or form.

SA: You have an excellent track record through bull and bear markets - can you discuss the key reasons for this?

Valkyrie Trading Society: Firstly, it’s the fact that we use a simple framework that assures that any stock that is owned has a large margin-of-safety. Then it is our philosophy that chaos is more likely than anyone thinks which is very rewarding in a fat-tailed environment like the current one.

We don’t believe that any of the market impacts we’ve seen over the last few years, whether positive or negative, were black swans. On the upside were things like the Trump rally, and on the downside were COVID-19 and the Ukraine war. All of these things were entirely plausible with the information in the lead-up to their market reactions, and you could position for them paying no premium for the hedge or leverage that select stocks offered in the face of those events. They were predictable at the time, even if as only one possible scenario, and were therefore not black swans or ‘unprecedented’.

For the war you had plenty of options in European defense. We invested heavily, almost 50% of our portfolio at the time, in Dassault Aviation (OTCPK:DUAVF). This stock had declined in the lead-up to the war. No one was speculating on the war with it at all. Also, it was ludicrously undervalued and fit perfectly our framework. The war might not have broken out, but it was a free hedge – everyone should have been buying this stock given the plentiful information that we had from even mainstream media on the diplomatic situation just prior to the invasion. We had an especially prescient article on the whole issue and why Dassault was the perfect pick, come what may, a month before the invasion. The effects of the (at the time) hypothetical invasion were also detailed out.

Things are far more chaotic than we like to believe. Also people tend to be smarter than you think, while organisations tend to be more stupid than you’d imagine. There isn’t so much protection from danger, and if anyone becomes determined to ruin things they are quite likely to succeed. Things can always go very wrong and we think about how a lot.

SA: You focus on obscure or under the radar stocks - how do you find these ideas in the first place? How (if at all) do you use stock screeners?

Valkyrie Trading Society: Some ideas come out of the network, but many are from just covering as broadly as possible on Seeking Alpha.

I also hear about many ideas in comments of my own articles and of others’. Likewise, the several people on my marketplace service also have lots to say and share. The downside with the SA readership is that they tend to be, and this is to their detriment, too US and Canada focused, which is a problem when you’re looking for international exposures which are typically systematically cheaper precisely because all the money in the US wants to avoid them for some reason.

For international stocks screeners are extremely useful, albeit tedious, for finding under the radar ideas. The SA screeners usually miss very little, and they are especially useful when giving valuations and sector-averages a cursory look as follow-up to potentially interesting ideas, but I use others too in more specific cases like with the Japan coverage when I expect value to be in the company’s reported holdings not often included in net cash values as the securities aren’t always super marketable.

Setting low P/B thresholds can be helpful for finding hidden value on the balance sheet, and that has been the go-to method lately especially with SoTP ideas. Otherwise, higher dividend yields can be helpful, as it could indicate more normalized income where PE metrics might be momentarily confounded by shocks. While we like dividends from a practical perspective, they have no bearing on value, so loss of confidence in a dividend or some other shock to income can be a moment to come in at panic prices. Otherwise, we just learn which companies produce products and services that we have a first principles belief in, and then find the cheapest company that operates in that market following our framework.

SA: You work from first principles to help find market inefficiencies - can you discuss this in-depth for readers who may not be as familiar with this type of thinking, and specifically how to apply it to investing? Can you give an example of how it helped you find an idea (or angle on a thesis) the market was missing?

Valkyrie Trading Society: The theory is that you start from axioms, basic truths you don’t need to make any assumptions to get to, and then build atop them by small, careful stages so that you save the assumption-making for later on in your analysis. So you might begin with a simple idea like supply and demand, and make a cumulative argument from there about potential forces.

We did this with Anglo American Platinum (OTCPK:ANGPY). The idea was simple, and that’s that there is a market for PGMs in autocatalysts already and it is growing because of increasing emission standards. Furthermore there is need for PGMs in the hydrogen energy economy. Finally, there are huge PGM reserves in Russia, which could become sanctioned or retaliate by restricting exports of those resources. The axiom is supply and demand, and the forces for higher price were quite unambiguous on a more secular basis. Yet, ANGPY traded below some other commodity companies whose resources don’t have the benefits of these special long-term trends and an electrification angle.

We no longer have a position, but the idea was well oriented with respect to the probable S/D forces at the time, and the value was unambiguous because it traded below more obvious plays and commodity companies whose resources were worse positioned.

Another use of first principle thinking is to come up with secular trends starting from the simplest needs and forces that could be important but people aren’t thinking about, and then start hunting down the cheapest idea related to that theme, or the cheapest cousin stock to that idea. A cousin stock is just any stock that will benefit from a trend but obliquely, through some association with the companies in the direct limelight. ANGPY’s renewable angle was actually a good example of this, where we found a resource necessary for hydrogen energy to be implemented at scale, but isn’t immediately associated to the opportunity which often carry a major future-proof premium.

Otherwise demographics, which is a first principle for any civilization, is usually a great place to start when thinking about secular forces.

SA: You made a great bullish call on Signature Aviation at the March 2020 low - what are your thoughts on the aviation industry in general now? Are there any under the radar stocks that will benefit from the ongoing recovery?

Valkyrie Trading Society: Thank you! That was a successful investment, and basically the mascot idea for our marketplace service. The mistake there was not sticking around for the bidding war that came after the first acquisition announcement.

We’re not so up to date on the aviation industry, but there is an angle that may still be un-mined, and that’s the reopening of intra-China aviation. There’s a couple of players out there who sell smaller jets that aren’t for the private and luxury market, but are for shorter distance regional travel. These backlogs may start to build with Chinese revenge travel. With people not having seen family for a while, but also restrictions on inbound Chinese tourism elsewhere, this could be interesting.

Embraer (ERJ) quite recently was approved for sale to Chinese regional carriers, and this might be a growth area for them that markets are not fully appreciating. Indeed, ERJ already has a pretty cutting-edge EVTOL exposure with EVE Holding that the market isn’t fully appreciating after VC markets collapsed. Dassault also remains pretty cheap thanks to major non-operating assets, but ERJ are similarly cheap and may have an earnings catalyst from China to update its price higher. The risk is that Chinese reopening isn’t quite as vigorous as some had hoped, but it’s a potential angle that we might look into again soon.

SA: How do you find companies with a strong moat or barrier to entry? Are there any companies with moats that are stronger than the market thinks?

Valkyrie Trading Society: The theory on moats is very well developed, and people have a good intuition for this idea. Infrastructural economics and set-up can be an interesting angle for companies that aren’t technically infrastructure companies, in the sense that they aren’t some natural monopoly like thoroughfares and airports. DDH1 has always felt that way to us for development in mines. Lately we’ve liked industries that tend to be more capital intensive and also provide necessary services agnostic to market forces, where capital intensity is the moat as funding costs rise.

A structurally advantaged way of looking at moats is to focus on network effects. This is a well understood idea, but because of a bias in which we can’t fully appraise just how aggressive network effects can be, you can rely on a structural undervaluation of network effects - it’s always a good angle. In that respect, we own IAC (IAC). We have a SoTP out on them. The only issue with them is that they depend on the eventual recovery of VC, at least to the upside. Still, they focus on businesses with great demand side economics, and have a really good track record with turning over companies like that – they used to own Tinder under Match Group (MTCH). They currently own Turo and Angi’s (ANGI) formerly known as Angie’s List, but also some other platforms that become more useful as more people engage with them. They own a lot of other public holdings too that don’t have any special angle to them, but those holdings help create the margin of safety in the SoTP. Getting any company with network effects in its business model for a bargain should be taken seriously, with network effects already being systematically undervalued. That’s the concept behind the IAC investment.

SA: Can you discuss the advantages and disadvantages of investing outside of the U.S.? Can you give an example of a non-U.S. stock that is as attractive (if not more so) than its U.S. peer?

Valkyrie Trading Society: We think there are structural reasons why markets outside of the US, even the developed ones, can trade at a discount for no fundamental reason. Internally, the US equity market is pretty big relative to the bond market. In most other developed countries, the bond market dwarfs the equity markets. Americans are very comfortable with stocks and it might come down to the fact that you have the privilege of Roth IRAs and have to save for your own retirement. In Europe there’s no Roth IRA and you pay quite high rates of your salary into very risk-averse pension funds. Stocks are more bid up in the US by internal actors than in other countries. Also, US markets have a lot more liquidity, related to all the previous points, and there’s probably some liquidity premium too which investors like us don’t really want or need to pay for. There are probably other structural reasons like the fact the tech stocks are in the US and that’s where money has been made in the last decades, and possibly the various regulation and tax elements like PFIC taxes that try to keep funds within the US rather than going abroad to foreign allocators with expertise in foreign markets.

Dassault Aviation was a great example: it traded at 0 EV while in the US defense would easily exceed 10x EV/EBITDA multiples. It still trades at less than half US defense EV/EBITDA multiples despite beating out the F-35 with the UAE. DDH1 trades lower in PE than Canadian deposit sample drilling peers in terms of PE. Aker ASA (OTCPK:AKAAF), another recent idea, also trades at much sharper discounts in its parts compared to US companies in the same markets. There’s also companies like Asseco Poland (OTCPK:ASOZF) whose tech consulting business consistently grows better than any I’ve seen in the US, but trades at a fraction of the typical tech consulting multiple.

SA: What’s one of your highest conviction ideas right now?

Valkyrie Trading Society: The highest conviction idea we have is TV Asahi (OTCPK:THDDY), which got Top 5 in the 2023 SA Stock competition. The valuation angle is very obvious, because the company trades at a negative EV, but what makes it special is that they have durable earnings growth from really quality franchises, but it doesn’t come from the core business.

The core business is TV broadcasting, which is a market that is in secular decline, although less so in Japan due to demographic factors. But part of the reason why TV Asahi trades at a negative EV is the substantial interests it has in growing Japanese firms, whose equity accounted income or dividends offset both secular but even pronounced current declines in TV broadcasting revenue on account to shrinking ad spend.

One of the interests is in the company that owns Glassdoor.com and Indeed.com, and that is an exciting enough company, but the exceptional, reopening fueled growth is coming from Toei Animation (OTC:TOEAF) which has the rights to One Piece and Dragon Ball merchandise, and also produces those megahit franchises’ respective movies. Because of the theater tailwind on reopening, Toei has done extremely well with some very popular movies. On its own, it’s a highly regarded company by markets, and its quality gives it a premium, but by buying TV Asahi you get to own it for free – actually you’re paid to own it.

TV Asahi also owns ABEMA in a J.V, which is Japan’s native streaming service. More or less tied with Netflix in first place in terms of market share, it is the go to place for streamed news and shows. ABEMA is a profit detractor now, but we believe (because there isn’t disclosure) that it’s about to start being a profit contributor like the other equity accounted holdings – so there’s more earnings growth in TV Asahi’s future.

The upside is in the triple digits in theory at 170%, although we don’t expect its assets to be monetized since there seems to be an implicit pact between companies to hold stock of other corporations. So the story here is the earnings growth from reopening, growth in Otaku culture, the resilience of major Toei franchises, emerging profitability of ABEMA and for a solid performance in the core business. As ABEMA scales as well as their income, we may see more shareholder payout over the 3.2% dividend yield. At any rate, there is going to be growth and there is a huge margin of safety.

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Thanks to Valkyrie Trading Society for the interview.

Valkyrie Trading Society is long DDHLF, MATW, DAWIF, IAC, THDDY – all owned on through their respective nations’ exchanges

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.