Stanphyl Capital November 2023 Letter

Stanphyl Capital’s letter to investors for the month ended November 30, 2023.

Friends and Fellow Investors:

For November 2023 the fund was down approximately 11.5%* net of all fees and expenses. By way of comparison, the S&P 500 was up 9.1% and the Russell 2000 was up 9.1%. Year-to-date the fund is down approximately 19.4% net. By way of comparison, the S&P 500 is up 20.8% and the Russell 2000 is up 4.2%. Since inception on June 1, 2011 the fund is up approximately 141.5% net while the S&P 500 is up 333.4% and the Russell 2000 is up 153.2%. Since inception the fund has compounded at approximately 7.3% net annually vs. 12.5% for the S&P 500 and 7.7% for the Russell 2000.  (The S&P and Russell performances are based on their “Total Returns” indices which include reinvested dividends. Investors will receive exact performance figures from the outside administrator within a week or two. Please note that individual partners’ returns will vary in accordance with their high-water marks.)

*Tesla, a large short position, was down substantially after the market closed on November 30^th, following the disappointing afternoon debut of its so-called “Cybertruck.” If that holds overnight (we mark our positions to the 4PM close) we’ll begin December with a significant performance “head start.”

This awful month was a reversal of the last several, with our longs doing well but our much larger short positions doing poorly in a fierce rally in what I still believe is a bear stock market. Here’s what I’m doing in response…

For reasons I clearly lay out below, I strongly believe the U.S. economy is headed for a “hard landing,” not the “soft” one that’s now clearly “consensus.” Yet this month the S&P 500 (our broad market short position, via the SPY ETF) rallied fiercely in response to declining bond yields (a natural outcome of the hard landing I expect!), going from very oversold at the end of October (accompanied by highly negative investor sentiment) to very overbought at the end of November (accompanied, naturally, by now highly bullish investor sentiment). This provided an opportunity to upsize our short position, and indeed after reducing it in late-October I did that as this month’s rally progressed. However…

November’s rally has been technically extremely strong and thus, from a shorting perspective, caution-inducing. I’ve thus set some very tight upside stops only slightly above where the market closed in November, and despite my fundamental perspective I’m prepared to roughly halve the size of our SPY short if those stops are triggered, then wait for the market to break down again before I re-upsize them.

Why do I believe so strongly that we face a hard landing and not a soft one? For the same reasons I’ve been stating for a while:

There’s no way an “everything bubble” built on over a decade of 0% interest rates and trillions of dollars of worldwide “quantitative easing” can not implode when confronted with 5% rates and $95 billion/month in U.S. quantitative tightening plus tighter money from the ECB, BOJ and other central banks.

Contrary to the belief of equity bulls, bubbles don’t unwind gently, and once they burst and the economy takes a dive it takes a long time before lower inflation and lower rates can sustainably reignite asset prices. When the 2000 bubble burst and the Nasdaq was down 83% through its 2002 low and the S&P 500 was down 50%, the rates of CPI inflation were just 3.4% in 2000, 2.8% in 2001 and 1.6% in 2002, and the Fed was cutting rates almost the entire time.

Meanwhile, the cost of servicing the Federal debt is soaring, thereby making extra fiscal stimulus unaffordable, while skyrocketing budget deficits with no serious plan to reduce them mean high long rates may be here to stay, simultaneously crushing economic activity and providing serious “investing competition” for stocks.

Yes, a nasty recession has been delayed due to a combination of “interest rate lag effects,” leftover “Covid cash” and “labor hoarding,” but it will soon arrive for the following reasons:

• Although the excess savings built up during the Covid pandemic kept a floor under consumer spending, those funds are now fully depleted for most Americans, and consumer credit card delinquencies are now rapidly increasing while personal savings have collapsed. Indeed, it does seem consumers are finally running out of spending power.
• Business lending data, shipping freight data and other leading indicators say that a nasty recession is imminent.
• In October student loan repayments finally resumed (although admittedly, many debtors will undoubtedly utilize the Biden administration’s one-year ”grace period“).

Keep in mind that even with the Fed now “on hold” with modest anticipated rate cuts in mid-2024, current stock market index valuations are unsustainable, as stocks are still expensive. According to Standard & Poor’s, Q3 2023 annualized run-rate operating earnings for the S&P 500 came in at around $210 and that was in a quarter of non-repeatable 5.2% real GDP growth! A 16x multiple on those earnings (generous for the current environment) would put that index at only around 3360 vs. its November close of 4567, while 15x would put it at around 3150. And again, those Q3 earnings occurred during a quarter of unrepeatable growth, so lower earnings in future quarters are quite possible. Also, just as in bull markets PE multiples usually overshoot to the upside, in bear markets they often overshoot to the downside. Thus, a bottom formed at a lower multiple of lower earnings is not unfathomable.

Meanwhile, although the high current rates of 4% core CPI and 3.5% core PCE are slowly trending down, I believe we’re in for a new core “inflation floor” of 3% to 4% as China is forced to stimulate its economy, Biden continues his war on fossil fuels, the U.S. government continues to rack up massive deficits, and substantial wage increases continue.  And even as inflation gradually declines, the Fed does not want to reverse rates too soon and repeat the 1970s.

Here then is some commentary on some of our additional positions; please note that we may add to or reduce them at any time…

We continue to own Volkswagen AG (via its VWAPY ADR, which represent “preference shares” that are identical to “ordinary” shares except they lack voting rights and thus sell at a discount). In October VW reported solid financial results for the first nine months of 2023, with revenue up 15.9% vs. 2022 (+11.6% for Q3 alone) and a 6.9% operating margin. VW currently sells for only around 3.6x its 2023 earnings estimate and controls a massive number of terrific brands including recently IPO’d Porsche, of which it owns 75% at a current market cap (for Porsche) of €77 billion, thus making VW’s €58 billion stake alone worth more than the entire €53 billion market cap of VW; in other words, at current prices you’re getting paid billions of euros to own all these other brands:

I believe Audi alone is worth at least €30 billion, while an IPO of the battery division or Lamborghini may be next. Additionally, the stock yields over 8% and VW has a full-bore commitment to EVs.

We continue to own automaker Stellantis (STLA), which in October reported a terrific Q3 (and first nine months of the year), yet currently sells for only around 3.4x estimated 2023 earnings with around €24 billion of net cash! I believe Jeep alone is worth most of the €36 billion EV of the entire company, which means a buyer gets Dodge, Chrysler, Ram Trucks, Fiat, Citroen, Peugeot, Opel, Alfa Romeo, Vauxhall, Lancia and Maserati almost “for free.” And Stellantis has a lot of EVs currently on the market (mostly in Europe so far) and many more coming worldwide.

I consider these positions (Stellantis, and VW) to be both “freestanding value stock buys” and “relative-value paired trades” against our Tesla short.

We continue to own a small position (I sold a chunk into November’s near-50% spike) in Rimini Street, Inc. (RMNI), an enterprise software product, support & services company. The “hair” on RMNI is that it’s perpetually being sued by Oracle, which doesn’t like RMNI capturing its revenue by servicing Oracle products. However, according to RMNI management the affected product (PeopleSoft) only accounts for 8% of RMNI’s revenue, and meanwhile at November’s closing price of $3.14/share, this is a 63% gross margin/10% operating margin company with $57M (.63/share) of net cash selling at an enterprise value of only around 0.53x revenue (assuming 89.4M shares outstanding and $420M in revenue). At its current valuation, it thus appears to have only modest downside with multiple potential routes to considerable upside.

We continue to own a small position in Fuel Tech Inc. (FTEK), a seller of air and water pollution control technologies, which in November reported a ­­­decent Q3, with revenue, gross margin and operating income all roughly flat year-over-year, at $8 million, 45% and $133,000 respectively. Management reiterated that 2023 revenue will be up slightly vs. 2022, at around $27 million. Meanwhile, at a current price of $1.06/share with 30.4 million shares outstanding and $33.2 million in cash and Treasuries (and no debt), Fuel Tech is selling for an enterprise value of approximately negative $1 million. This is the kind of company that will either ignite growth and its stock will climb higher (as its core fossil-fuel pollution treatment business is in a long-term, government-mandated decline, its new “Dissolved Gas Infusion” water treatment is the potential medium-term catalyst for that), or it’s cheap enough to make a good strategic acquisition target, as removing the costs of being an independent public company could make it instantly earnings-accretive while allowing the buyer to acquire a nice chunk of revenue cheaply. The risk here is that if there’s no acquisition and the water treatment business (which announced promising test data in the Q3 earnings release) doesn’t pan out, Fuel Tech will become what Buffett might have called “a cigar butt business with just a few puffs left in it” (albeit pollution-controlled puffs). Thus, this should be a very small position in anyone’s portfolio, as it is in ours.

And now, Tesla…

In November Elon Musk alienated millions of additional potential Tesla buyers (beyond the millions his regularly abhorrent behavior previously alienated) by endorsing a blatantly antisemitic tweet and engaging in “Pizzagate” conspiracy theories. Naturally, Tesla’s sycophantic Board (the worst in the history of public companies) did nothing in response to this insane behavior, despite the fact that…

In October Tesla reported a disastrous Q3, with sequentially declining deliveries despite continual price-cutting (and it kicked off Q4 with yet more price-cutting!) and diluted GAAP earnings of just .53/share—down 44% (!) from the year-ago quarter. (And around .08 of that .53 came from interest on Tesla’s cash balance, not the business itself!) Operating margin declined to an auto industry-average of just 7.6% vs. 17.2% a year ago, and that 7.6% included massive regulatory credit sales—without them it was only around 5.2%! Tesla is undeniably now just an average-margin car company* forced to continually cut prices to maintain delivery volume, and with annualized earnings of just $2.12/share in an industry with PE ratios of 4x to 8x, it’s generously a $20 stock.*(Tesla’s nearly irrelevant “energy business” accounts for less than 7% of revenue.)

To make matters worse, Tesla will soon open its U.S. charging stations to cars from most other manufacturers which, in turn, will adopt Tesla’s connector and charging protocol. (Those competitors are building their own networks, too.) Seeing as many people only buy a Tesla instead of a competing EV in order to access those chargers, and seeing as all the competing charging networks will also adopt this protocol while paying Tesla nothing (Tesla open-sourced it), this will cost Tesla far more in lost auto sale profits than the pennies per share it may gain from charging profits.

Meanwhile, Tesla has objectively lost its “product edge,” with many competing cars now offering comparable or better real-world range, better interiors, similar or faster charging speeds and much better quality. In fact, Tesla ranks near the bottom of the 2023 JD Power survey and its Model 3 is the worst car (out of 111!) in Germany’s rigid safety inspection system!

Tesla’s poorly-built Model Y faces competition from the much better made (and often just better) electric Hyundai Ioniq 5, Kia EV6, Ford Mustang Mach E, Cadillac Lyriq, Nissan Ariya, Audi Q4 e-tron, BMW iX3, Mercedes EQB, Chevrolet Blazer EV & Equinox EV, Volvo XC-40 Recharge, Honda Prologue and Polestar 3, as well as multiple Chinese models in Europe and Asia. And Tesla’s Model 3 has terrific direct “sedan competition” from Volvo’s beautiful Polestar 2, BMW’s i4, Hyundai’s Ioniq 6 and Volkswagen’s ID.7, as well as many local competitors in China.

And in the high-end electric car segment worldwide the Porsche Taycan outsells the Model S, while the spectacular new BMW i7 and i5, Mercedes EQS and EQE, Audi e-Tron GT and Lucid Air make the Tesla look like a fast Yugo, while the BMW iX, Mercedes EQS SUV and Audi Q8 eTron do the same to the Model X.

And oh, the joke of a “pickup truck” Tesla first previewed in 2019 won’t be much of a “growth engine” either, as by the time it’s in meaningful mass-production in 2024 that grotesque-looking kluge will enter a dogfight of a market vs. Ford’s F-150 Lightning, GM’s electric Silverado, the Dodge Ram REV and Rivian’s R1T.

Meanwhile, in August Tesla’s CFO suddenly quit (or was fired) on no notice, the latest in a series of sudden and unexplained Tesla CFO departures. This may be tied into the possibility that the DOJ is close to criminally indicting Elon Musk following the revelation of a massive & systemic Musk-directed consumer fraud regarding the range of Tesla’s cars, his alleged attempted theft of company assets to build himself a house, and Handelsblatt’s story about a massive & systemic Tesla safety cover-up while people continue to die in (or because of) Teslas at an astounding pace. In fact, Tesla’s Q3 10-Q confirmed that the company has received multiple subpoenas regarding all these transgressions. Whether from these crimes or something else, Musk will go down because fraudsters like him always do… even if he thinks he has an “airtight strategy” (blackmail?) to combat these regulators:

Meanwhile, the NHTSA has initiated the first of what will likely be multiple recalls of Tesla’s fraudulently named “Full Self Driving” (even before the aforementioned safety cover-up revealed by Handelsblatt), and in January it was revealed that Elon Musk personally directed its fake, fraudulent promotional video (something extremely similar to what Theranos did with its blood machines and Nikola with its truck). The refund liability potential for Tesla for this is in the billions of dollars, and possibly even the tens of billions if a class action lawsuit proves that the cars involved were purchased solely due to the (fallacious) promise of “full self-driving.” And, of course, there will be a massive “valuation reappraisal” for Tesla’s stock as the world wakes up to the fact that its so-called “autonomy technology” is deadly, trailing-edge garbage that Consumer Reports now ranks just seventh vs. competitors’ systems (behind Ford, GM, Mercedes, BMW, Toyota and Volkswagen) and Guidehouse Insights now rates dead last:

Yet Tesla has sold this trashy software for over seven years now…

…and still promotes it on its website via the aforementioned completely fraudulent video!

Another favorite Tesla hype story has been built around so-called “proprietary battery technology.” In fact though, Tesla has nothing proprietary there—it doesn’t make them, it buys them from Panasonic, CATL and LG, and it’s the biggest liar in the industry regarding the real-world range of its cars. And if new-format 4680 cells enter the market, even if Tesla makes some of its own,  other manufacturers will gladly sell them to anyone, and BMW has already announced it will buy them from CATL and EVE.

Meanwhile, here is Tesla’s competition in cars…

(note: these links are regularly updated)

• Porsche Taycan
• Porsche Macan Electric Coming in 2024
• Volkswagen ID.3
• Volkswagen ID.4 Electric SUV
• Volkswagen ID.6 SUV EV in China
• Volkswagen ID.Buzz Electric Van
• Volkswagen ID.7
• VW’s ID.2all compact EV will cost under €25,000 when it arrives in 2025
• VW’s Cupra Born
• Volkswagen Group Will Spend $200 Billion To Boost Its EV Business
• Audi Q8 e-tron electric SUV
• Audi e-tron GT
• Audi Q4 e-tron
• Audi Q6 e-tron electric SUV
• Audi A6 E-tron due in early 2024 with saloon, estate and hot RS6
• Hyundai Ioniq 5
• Hyundai Ioniq 6
• Hyundai Kona Electric
• Genesis GV60
• Genesis GV70
• Kia Niro
• Kia EV6
• Kia EV9
• Kia EV5
• Kia EV4
• Jaguar’s All-Electric i-Pace
• Mercedes EQS
• Mercedes EQS SUV
• Mercedes EQE
• Mercedes EQE SUV
• Mercedes EQC electric SUV available in Europe & China
• Mercedes EQV Electric Passenger Van
• Mercedes EQB
• Mercedes EQA SUV
• Mercedes CLA (2025 model)
• Ford Mustang Mach-E
• Ford F-150 Lightning
• Ford to launch 7 EVs in Europe in big electric push
• Ford unveils Lincoln Star electric SUV concept as it readies to add four new EVs by 2026
• Chevrolet Blazer EV
• Chevrolet Equinox EV
• Chevrolet Bolt
• Chevrolet Bolt EUV electric crossover
• Cadillac All-Electric Lyriq
• Cadillac to start making 3 more EVs in 2024
• GMC Electric Hummer Pick-Up and SUV
• GM electric Silverado pickup truck
• GMC Sierra EV Denali
• Honda Prologue
• BMW iX1
• BMW iX3
• BMW iX
• BMW i4
• BMW i5
• BMW i7
• BMW Neue Klasse (2025 model)
• Nissan Ariya: All-Electric Crossover SUV
• Nissan LEAF e+
• Polestar 2 sedan
• Polestar 3 electric SUV
• Volvo EX30
• Volvo XC40 Recharge electric SUV
• Volvo C40 Recharge electric crossover
• Volvo EX90 electric SUV
• Acura ZDX
• Jeep will launch 4 all-electric SUVs by 2025, including Wagoneer and ‘Wrangler’ EVs
• Renault Scenic E-Tech
• Renault Zoe electric
• Renault to boost low-volume Alpine brand with 3 EVs
• Renault’s Megane E-Tech
• How Renault’s Ampere aims to be Europe’s leader in EVs, software-defined cars
• Dodge Ram 1500 REV
• Peugeot e-208
• Peugeot E-2008
• Peugeot E-308
• Peugeot’s full-electric 3008 and 5008 SUVs will have up to 700 km range
• Citroen E-C3
• Subaru Solterra
• Subaru accelerates U.S. electric plans with local production and 8-model EV lineup
• Honda, Sony to start premium EV deliveries in 2026
• Honda pours $40 billion into electrification, targets 2 million EV production by 2030
• Rivian electric pickup trucks & SUVs
• Maserati Grecale Folgore
• Mini Cooper SE Electric
• Toyota bZ4X
• Toyota and Lexus Will Launch 10 New EVs By 2026
• Opel Corsa-e
• Opel Astra electric
• Vauxhall Mokka electric
• Skoda Enyaq iV electric SUV
• Skoda Enyaq electric coupe
• BYD presents three BEVs for European market
• Nio expands into Europe and beyond
• Lucid Motors: Electric Luxury Cars
• Fisker Ocean
• Rolls-Royce Electric Spectre
• Bentley will start output of first full EV in 2025
• Aston Martin will build electric vehicles in UK from 2025

And in China…

• BYD is #1 in Chinese EVs, selling FAR more than Tesla
• Volkswagen Group Accelerates Electrification Drive to Boost Presence in Chinese Market
• Audi, SAIC EV Tie-Up a ‘Coming of Age’ for Chinese Automaking
• Audi-FAW’s $3.3 billion electric vehicle venture
• Nio
• Xpeng Motors
• Hozon/Neta
• Li Auto
• GAC Aion
• Leap Motors
• GM plans to launch over 15 EV models in China by 2025
• Ford Mustang Mach-E Rolls Off Assembly Line in China
• Cheaper than Tesla: Honda takes aim at China’s middle class
• BMW i3 Debuts As All-Electric 3 Series Only For China
• Hongqi
• Geely
• Zeekr Premium EVs by Geely
• Baidu and Geely put nearly $400 million more into their electric car venture
• China-made Mercedes-Benz EQE hits market
• BAIC
• Hyundai, BAIC Motor to inject $942 mn in China JV for EVs
• Toyota partners with BYD to build affordable $30,000 electric car
• Lexus RZ 450e Steers For China
• Dongfeng
• SAIC
• Renault launches sales of first EV in China
• Nissan expects 40% of sales in China to be electrified by 2026
• Changan forms subsidiary Avatar Technology to develop smart EVs with Huawei, CATL
• Chery
• Seres
• Enovate
• Singulato
• JAC Motors
• Iconiq Motors
• Aiways
• Skyworth Auto
• Youxia
• Human Horizons
• Xiaomi announces plans for four electric vehicle models

Here’s Tesla’s competition in autonomous driving; the independents all have deals with major OEMs…

• Waymo ranked top & Tesla last in Guidehouse leaderboard on automated driving systems
• Tesla has a self-driving strategy other companies abandoned years ago
• Waymo operates robotaxis NOW
• GM’s Cruise operates robotaxis NOW
• Mobileye operates driverless test fleets in Europe and the U.S.
• Cadillac Super Cruise™ Sets the Standard for Hands-Free Highway Driving
• Ford’s hands-free “Blue Cruise”
• Mercedes Launches SAE Level 3 Drive Pilot System
• Honda Legend Sedan with Level 3 Autonomy Now Available in Japan
• Motional (Hyundai) & Uber Announce Autonomous Ride-hail and Delivery Services
• Stellantis Completes Acquisition of aiMotive to Accelerate Autonomous Driving Journey
• Amazon’s Zoox will test its autonomous vehicles on Seattle’s rainy streets
• Baidu to further deploy 200 driverless vehicles in China in 2023
• Baidu Apollo City Driving Max
• Alibaba-backed AutoX unveils first driverless RoboTaxi production line in China
• Pony.ai approved for public driverless robotaxi service in Beijing
• SAIC-backed Xiangdao Chuxing kicks off Robotaxi pilot operation in Shenzhen
• WeRide greenlighted for autonomous road test with empty driver’s seat in Beijing
• GAC-backed Ontime greenlighted for pilot operation of Robotaxi service in Guangzhou
• Xpeng debuts most advanced semi-autonomous driving system to rival Tesla

Here’s where Tesla’s competition will get its battery cells…

• Panasonic (making deals with multiple automakers)
• LG
• Samsung
• SK Innovation
• Toshiba
• CATL
• BYD
• Northvolt
• Volkswagen to Build Six Electric-Vehicle Battery Factories in Europe
• GM’s Ultium
• GM to develop lithium-metal batteries with SolidEnergy Systems
• Ford building $2 billion battery plant in Michigan
• SK On and Ford form BlueOval SK, an EV battery joint venture
• Hyundai teams with SK to make batteries for U.S.-built EVs
• Hyundai Motor developing solid-state EV batteries
• BMW & Ford Invest in Solid Power to Secure All Solid-State Batteries for Future Electric Vehicles
• Stellantis affirms commitment to build battery factory in Italy with Mercedes, TotalEnergies
• Stellantis and Samsung SDI to Invest Over $2.5B in Battery Production Plant in United States
• Stellantis and LG to Invest Over $5 Billion CAD in Joint Venture for Li-Ion Battery Plant in Canada
• Stellantis and Factorial Energy to Jointly Develop Solid-State Batteries for Electric Vehicles
• Mercedes-Benz to build 8 battery factories in push to become electric-only automaker
• Mercedes-Benz and Sila achieve breakthrough with high silicon automotive battery
• Toyota pledges $2.1bn more for U.S. EV battery plant
• Toyota to roll out solid-state-battery EVs as soon as 2027
• Nissan preps an old engine plant to make solid-state EV batteries
• Honda and LG Energy Formally Establish Battery Production Joint Venture
• Honda, GS Yuasa agree to collaborate in lithium-ion batteries
• Daimler joins Stellantis as partner in European battery cell venture ACC
• Renault signs EV battery deals with Envision, Verkor for French plants
• Nissan to build $1.4bn EV battery plant in UK with Chinese partner
• Nissan Announces Proprietary Solid-State Batteries
• Foxconn breaks ground on first EV battery plant
• Envision-AESC
• ONE
• EVE
• Freyr
• Verkor
• Farasis
• Microvast
• Akasol
• Cenat
• Wanxiang
• Eve Energy
• Svolt
• Romeo Power
• ProLogium
• Morrow
• Amprius
• CALB

And here’s Tesla’s competition in storage batteries…

• Panasonic
• Samsung
• LG Energy Solutions
• CATL
• BYD
• AES + Siemens (Fluence)
• Hitachi ABB
• Toshiba
• Saft
• Johnson Contols
• EnerSys
• SOLARWATT
• Sonnen
• Generac
• GM Energy
• Canadian Solar
• Kokam
• Eaton
• Tesvolt
• Leclanche
• Lockheed Martin
• Honeywell
• EOS Energy Storage
• ESS
• Electriq Power
• Redflow
• Primus Power
• Simpliphi Power
• Invinity
• Murata
• Bollore
• Adara
• Blue Planet
• Aggreko
• Orison
• Powin Energy
• Nidec
• Powervault
• Kore Power
• Shanghai Electric
• LithiumWerks
• Natron Energy
• Energy Vault
• Ambri
• Voltstorage
• Cadenza Innovation
• Morrow
• Gridtential
• Villara
• Elestor
• SolarEdge
• Q-Cells
• Huawei
• Toyota
• ADS-TEC
• Form Energy
• Enphase
• Sumitomo Electric
• Stryten Energy
• Freyr
• Growatt
• Polarium
• Alfen
• Quino Energy
• Gotion
• ZincFive
• Dragonfly Energy
• Salgenx
• Lunar Energy

Thanks,

Mark Spiegel

Stanphyl Capital