Apis Flagship Fund Q1 2024 Commentary

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Apis Flagship Fund

Apis Flagship Fund commentary for the first quarter ended March 31, 2024.

Dear Partners,

Our Flagship Fund was up 9.5% net in Q1 2024. During the past quarter, our longs contributed 10.3% (gross) and our shorts added 1.4% (gross). At the end of March, the Fund was approximately 55% net long with the portfolio 87% long and 33% short.

Performance Overview (Gross Returns)

2024 kicked off on a positive note thanks to solid stock-picking. Long-side returns exceeded the market and short performance was exceptional, making a positive contribution against an upward tide to markets generally. Regional contributions were balanced, with Asia and North America adding roughly 4.0% each (gross) during the quarter and Europe also providing 3.3%. From a sector perspective, the standout performance by far was from Industrials, which added 10.0% to returns while other sectors were modestly positive.

Top long contributors were also diversified, led by HD Hyundai Electric (Korea) adding 2.3% during the quarter on the back of strong earnings and a very strong outlook. As we have highlighted previously, the electrical grid is seeing long overdue updates with additional capacity needed to accommodate “green” energy. On top of that, markets are beginning to re-rate electric equipment producers (e.g., transformers, switchgears, cables, etc.) as “AI” plays since AI data centers require enormous amounts of power. Estimates are all over the map with “worst case” predictions forecasting 24%(!) of global power consumption taken by data centers in 2030 from roughly 5% today. More realistic forecasts still expect data center power needs to more than double by the end of the decade, consuming more than 10% of the world’s electricity. With power growth generally increasing by about 0.5% per year, that rate will need to double.

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Other significant long contributors came from defense-related companies, with three names in the top 10 contributing 3.8% in total. We highlight the broader defense theme in more detail below. The top long detractor was Aixtron, which lost almost 1.0%. The company fell on fears of slowing EV penetration and news that Apple is abandoning efforts in micro-LED. We have reduced the position, but it remains a small holding as bigger-picture trends still support growth.

Shorts rebounded from their poor Q4 performance as many of the “low quality” names that ran last year (and we lamented about) fell back to earth. One thing that limits the upside to these names is their enormous cash burn – any pop in share price eventually gets met with share sales as they look to extend their runway a few more quarters. Four of the top 10 short performers came in the solar energy area as prices continued to fall. Manufacturers are trying to resist price pressures while many service businesses built on cheap customer financing struggle to stay afloat.

Portfolio Outlook And Positioning

There were no dramatic changes to positioning – Asia continues to have the highest gross and net positioning with North American exposure up a few points from last year and European exposure down a few points from the same period. Likewise, sector exposures remain similar to the end of 2023 with Industrials and Technology leading, although gross exposures to the Consumer area are up 6.0% as we have a couple of new longs and shorts we are excited about.

From a handful of names last year, the first quarter contains more evidence of a broadening market. Our smallest names (sub-$1bn market cap), which account for about 25% of net exposure, still only contributed 7.0% of our performance. This is not ideal, but better than the losses we faced last year. Should the broadening trend continue to work its way down, we are in a position to benefit.

Investment Highlights


Countries typically spend a few percent of their GDP on defense, which may sound small, but often accounts for the bulk of discretionary government spending (excluding things like social security and interest on debt). For example, in the U.S., defense spending is about ½ of the $1.7 trillion in discretionary spending, representing the largest line-item in the discretionary budget. When most people think of defense spending, they think of warships, guns, planes, etc., but this “procurement” piece is relatively small, accounting for just about 1/5th of the defense budget in the U.S. The remaining 4/5ths comprises items such as salaries, housing, food, equipment maintenance, R&D, etc. As a result, when countries raise their defense spending, a disproportionate amount is typically spent “catching up” on their procurement as they are prone to neglecting these items in times of peace. With the recent conflict between Russia and Ukraine and threatening geopolitical conflicts around the world, this “catching up” dynamic is playing out across several countries.

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As has been widely reported, the world is ramping up defense spending. Russia and China have increased their spending by about 300% and 600%, respectively, over the past decade as compared to Europe, which has only raised theirs by 20%. That is now changing with Germany leading the way. The country spent about 1.3% of GDP on defense for much of the 2000s, recently amounting to roughly $55 billion per year. After the Russia-Ukraine War commenced, Germany committed to raising this to at least 2% and passed an additional budget of 100 billion Euros. Japan has similarly committed to double its budget from 1% to ~2%, adding about $50 billion per year to its spending. Numerous other countries in Europe have also committed to increased spending with the most notable being Poland. Poland may be a leading indication of what is in store for many of the European countries. The budget in Poland has sharply risen from 2% to 4%, and the government has rushed to add heavy artillery pieces such as tanks and howitzers. While Poland preferred to “buy local,” they were compelled to turn to Korea after learning that European suppliers could deliver just one tank per month while the Koreans were prepared to deliver 5-10x that rate at a meaningful price discount.

Anecdotes of shortages abound. A commonly used shell – the 155mm artillery shell – is being consumed at a rate of 110,000 per month while production capacity is just 28,000 per month and not expected to reach the rate of consumption until next year. Prices for these shells reportedly increased from approximately $2,200 per round to a peak of nearly $8,500 since the start of the war. According to The Wall Street Journal,1 France “has fewer than 90 heavy artillery pieces, equivalent to what Russia loses roughly every month on the Ukraine battlefield…” and similarly, “West Germany alone had more than 7,000 battle tanks by the 1980s; reunified Germany now has 200, only half of which are likely operational, according to government officials.” These examples and many others have been widely reported and reflect the moribund state of preparedness in Europe resulting from decades of austerity.

The defense sector has begun to reawaken on the back of this increased spending. Amongst the U.S. & its allies, the U.S. has dominated both defense production and spending, albeit at a slow pace of growth. However, amongst allies, equipment production has been much harder to grow than spending. Production requires years to prepare infrastructure, perform testing, R&D, etc. Europe’s failure to invest has left the defense sector lacking in economies of scale and, possibly worse, with supply chains scattered across the Balkanized continent as each country tries to get a piece of the production of any item they agree to purchase. This has also left the continent with far too many defense weapons systems for every weapon category. For example, Europe has 15 different types of tanks whereas the U.S. has just one. For howitzers, Europe has 23 different systems versus the U.S. with two. This problem extends to everything from destroyer ships to fighter planes. The effect is to dramatically slow down the operational availability of equipment as spare parts are unavailable, know-how is scattered and economies of scale are lacking.

As mentioned earlier, Poland was forced to turn to Korea in response to this problem with an order for 600 tanks from Hyundai Rotem and 1,000 howitzers from Hanwha Aerospace. These are multi-billion dollar orders as each item can cost a few million dollars or more. Korea has become an exporting powerhouse for defense equipment over the past two years. The country has been at war with North Korea for decades and has maintained a modern full-scale military with localized production of nearly every major defense system from airplanes to tanks and munitions and electronics. This is unique amongst the Western countries and their allies.

Hanwha Aerospace (Korea – $8bn market cap)

This company first appeared on our radar after reporting a surge in orders, which has now driven their backlog to about 6x their revenues, providing extraordinary financial visibility. Hanwha produces the “K9” howitzer and claims 60% market share for exports of howitzers worldwide. Strong orders for the K9 and other products have driven sales growth at a 15-30% annual rate, far faster than the typical GDP+ growth seen by most defense companies. Foreign sales are also much more profitable as margins are often in the 20-30% range rather than the 5-10% range for domestic sales. As the mix of exports surges higher, we expect earnings growth to far outpace revenue growth.

Moreover, the exports appear to be just scratching the surface as the rest of Europe, and particularly those nations bordering Russia/Ukraine, are actively engaging Korea to order urgently needed equipment. The potential for additional orders is multiples of what Poland has already granted, which alone has been transformational for Hanwha. Moreover, Hanwha has numerous potential catalysts as it recently acquired a minority stake in a shipbuilder in order to deliver navy vessels, and the company just announced its intention to spin off its non-defense-related businesses. Currently, the stock is valued at less than 15x forward earnings, which is not too far from blue chip western peers growing at a fraction of the speed. However, we think earnings could positively surprise as the company downplays its margins on foreign orders – they don’t want their customers to find out that despite underpricing competitors in Europe by as much as 1/3rd, they are able to realize nearly unheard-of defense margins on their exports. Just look at industries such as automotive, chip memory, and shipbuilding for historical examples where Korea achieved similar financial benefits in the export market.

Hyundai Rotem (Korea – $3bn market cap)

A nearly identical scenario has been playing out with another Korean defense company named Hyundai Rotem, which is a manufacturer of tanks and trains. They have an initial contract for 180 tanks called the “K2” out of a framework agreement with Poland for a total of 1,000 units. The “K2” can trace its heritage back to the American Abrams tank that General Dynamics produced. Much of Korea’s defense industry has legacy connections to the U.S., extending as far back as the Korean War. As a result of Rotem’s success with the K2, the company’s defense exports have surged from 0% in 2020 to an estimated 70%+ of defense sales in 2025. Similar to Hanwha Aerospace, the profit margins on these export sales approach 20%+ versus low-single-digits for domestic Korean sales. As a result, the overall contribution to profits from defense sales is expected to rise to 90%+ of company earnings. Romania is also rumored to be negotiating an order for 250 tanks and the Czech Republic is expected to place an order as well. The stock is currently valued at about 12x forward earnings, but as with Hanwha, we think there is significant upside to these numbers as margins are being underestimated and potential orders from additional countries are not being considered.

Poongsan Corporation (Korea – $1bn market cap)

The last position we have in Korean defense is in Poongsan, whose business is focused on two seemingly unrelated areas – copper refining and munitions. The world has very few munitions pure plays as most of these businesses are either owned by governments or small parts of large conglomerates. As mentioned earlier, the price of 155mm shells has doubled or more and shortages have become extreme. By law, Korea does not allow defense exports to war zones which is why they are not selling their arms directly into Ukraine. Rather, the orders have been to restock inventory in Europe and the U.S. Poongsan’s munitions can be used with Korean howitzers and tanks as well as western produced equipment. The company recently announced a doubling of capacity for its munitions business. Disclosure is very limited but given what we have seen from European peers (namely Rheinmetall discussed below), we suspect the margins on these exports are in the 25-30%+ range, dramatically higher than domestic Korean margins. Historically, the copper refining division has contributed 50-60% of company earnings and, as a result, the market has placed a low earnings multiple on the stock, typically 4-8x p/e. With the increased contribution from defense, the mix from copper should drop substantially and the market should place a much higher multiple on earnings. Recently, Rheinmetall purchased a private munitions producer in Spain paying 1.2 billion Euros for 400 million of sales. Using this ratio to value, Poongsan would at least double the stock price and we would still get the copper business for free. It should also be noted that copper is seeing a resurgence in price which is expected to drive Poongsan’s copper profits much higher as well.

Rheinmetall (Germany – $25bn market cap)

This was one of the first stocks we bought within this theme last year as a sub-$10bn market cap and it has performed exceptionally well, including a near-doubling year-to-date. The company is diversified across a number of platforms similar to its American counterparts. It is the national defense champion of Germany and will continue to receive much of the German order-flow as a result. Up until recently, valuation for the European defense sector (and globally) was depressed by concerns around ESG and a general lack of demand. As both of these overhangs have receded, Rheinmetall’s forward p/e ratio has risen from low double digits to nearly 20x earnings, a level comparable to blue-chip peers in the U.S. Moreover, earnings estimates have increased significantly, with estimates for 2024 and 2025 almost doubling over the past two years. While the market cap has risen above the typical range of our holdings, we remain holders as we believe the defense investment being undertaken across Europe will last a decade or more and drive growth that is multiples higher than the GDP+ growth achieved by blue-chip peers in the U.S.

As always, we encourage your questions and comments, so please do not hesitate to call our team here at Apis or Will Dombrowski at +1.203.409.6301.


Daniel Barker

Portfolio Manager & Managing Member

Eric Almeraz

Director of Research & Managing Member

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