The Fund generated an attractive absolute return in the third quarter, led by three of the Fund’s largest positions. AMREP Corporation (AXR) began the quarter as the largest position in the Fund and was also the top performer, rising over 60% as the company monetized some of its real estate holdings and utilized cash to reduce debt. Gulf Island Fabrication (GIFI) advanced 33% during the quarter as the company reported strong Q2 earnings, overcoming a low energy price environment. PICO Holdings (PICO) increased 25% during the quarter as shareholders reacted positively to improvements in corporate governance. The stock has continued to perform well thus far in Q4 following the company’s sale of non-core energy assets and the announcement that the board had replaced the former CEO. The Fund ended the third quarter with 14 positions. The largest position was 16% of the portfolio and the top five positions represented 57% of the portfolio. The Fund added three new positions during the quarter and exited our position in Gencor Industries (GENC). Gencor first became a position in 2012 and was added to the portfolio due to its attractive valuation (negative enterprise value), strong market share, tight cost controls, and our belief that the highway construction market was likely near a cyclical low. The passage of a long-term highway bill in December 2015 resulted in a strong increase in orders and improved profitability. We exited the position after the stock price reached our price target.
The portfolio consists entirely of deep-value microcap companies providing a considerable margin of safety and the potential for capital appreciation. The deep value focus is evident as the average portfolio company has a Price/Book ratio of 0.9x and an Enterprise Value/EBITDA ratio of 6.1x. These valuation metrics compare favorably to the S&P 500 which has a Price/Book ratio of 2.9x and an Enterprise Value/EBITDA ratio of 12.5x. The average portfolio company has a market capitalization of $97 million and an enterprise value of $85 million. The companies in our portfolio also have conservatively managed capital structures, with 10 of our 14 portfolio companies having more cash than debt on the balance sheet. Given the combination of low interest rates and open credit markets, other investors might suggest that the majority of our portfolio companies could benefit from increased financial leverage in order to pursue acquisitions, repurchase shares, or pay dividends. While we recognize the merits to these suggestions, we sleep well at night knowing that our portfolio companies are not reliant on the kindness of outsiders for liquidity in the event the credit markets suddenly dry up.
Divided by sector, 22% of the portfolio is in real estate (primarily land), 18% in water, 15% in energy, 13% in industrials, 7% in consumer products, 6% in retail, 3% in gaming, 1% in timberland, and 16% in cash. As mentioned in last quarter’s letter, the composition of the portfolio has recently shifted to include a higher proportion of real estate and water assets. We remain positive on the U.S. housing market and believe demand for both land and water assets should continue to improve as new home construction approaches long-term averages. In addition, the availability of affordable lots has decreased as excess inventory leftover from the financial crisis has largely been utilized. In our position commentary, we explore a core holding that has significant land holdings on the island of Maui in the state of Hawaii. The company is also one of our few holdings that has debt on the balance sheet and provides a great example of the pitfalls that financial leverage can bring along with the potential rewards that can come from paying debt down.
[us_separator] The above post has been excerpted from a recent letter of Gate City Capital Management.
Performance for the period from September 2011 through August 2014 has undergone an Examination by Spicer Jeffries LLP. Performance for the period from September 2014 through December 2015 has undergone an Audit by Spicer Jeffries LLP. Performance for 2016 is unaudited. The performance results presented above reflect the reinvestment of interest, dividends and capital gains. The Fund did not charge any fees prior to September 2014. The results shown prior to September 2014 do not reflect the deduction of costs, including management fees, that would have been payable to manage the portfolio and that would have reduced the portfolio’s returns. Actual performance results will be reduced by fees including, but not limited to, investment management fees and other costs such as custodial, reporting, evaluation and advisory services. The net compounded impact of the deduction of such fees over time will be affected by the amount of the fees, the time period and investment performance. Specific calculations of net of fees performance can be provided upon request.