I didn’t quite finish looking into the Charles Mizrahi pitch for his 8-Figure Fortunes newsletter ($1,495/yr) yesterday, so I thought we’d get into that for a moment as a little bonus (don’t worry, the Friday File is coming later today, too)…

… in addition to his oil-stock-for-2023/">“number one small cap oil stock” that was the focus of his pitch, Mizrahi also touted some other picks that are in what he calls his “Smart Money Portfolio,” and I was curious about what those might be.

So, without further ado… our clues!

“Inside this report are three powerhouse companies that have recently attracted large institutional ownership.

“One is an oil sands producer that generates 14% of Canada’s oil production. Right now, according to Charles, it’s trading for a 25% discount — meaning if each share was $1, you could buy it for $0.75! Elliott Management recently purchased a $2 billion position in the company.”

That wasn’t all that “recent” now, Elliott got involved with this company last Spring… but what Mizrahi is teasing here is the Canadian oil giant Suncor (SU), which is indeed mostly an oil sands producer in Western Canada (though they also do conventional and offshore production, and own a bunch of gas stations).

Suncor was an activist target of Elliott Management last year, they first disclosed a large stake (3.2%) about a year ago… here’s part of the message they sent to management, per a FT article at the time:

“Elliott, which said it was one of Suncor’s top shareholders with a 3.4 per cent stake, hit out at a ‘slow-moving, overly bureaucratic corporate culture” that left the company underperforming peers and failing to exploit a strong position atop the world’s third-largest proven oil reserves.

‘With the right leadership, the company can restore its prior success,’ Elliott wrote in a letter to the board dated Thursday. ‘Suncor’s integrated oil sands operations are a critical part of the global energy supply, and we believe these assets are dramatically undervalued.'”

The day before that disclosure was made, oil was at about $100 and Suncor shares were at about $32.50. Here’s what happened in the interim — crude oil is down about 25%, and there’s been a small return for SU shareholders of 3.5%, entirely because of the dividend:

So if Suncor is going to close that valuation gap with its peers, and restructure the company to try to streamline operations and gets some credit for the long-life value of its reserves, as Elliott believes it can, there’s still a possible 50% gain or so on the table. So far, the performance has not been good… and under their “peace agreement” with management, that gave Elliott the right to add a fourth board members (they already have three).

There are a lot of ways to look at the valuation gap, the other big operators in the oil sands are Imperial Oil (IMO), Cenovus Energy (CVE) and Canadian Natural Resources (CNQ), and I’m sure they’re not really exact comparisons… but Suncor has often been cheaper than those on a price/earnings or price/cash flow basis, and, probably more importantly, the total return for shareholders, largely due to much stronger production and earnings growth at the others, has lagged pretty dramatically since COVID — that’s SU down there in green:

And that hasn’t always been so, SU was more “middle of the pack” most of the time in the decade before that. So perhaps there are short-term issues that can be fixed (SU still in green here):

Suncor is expected to earn about $4.50 per share this year (down from the Russia-driven $6.24 last year), and production should either be stable or grow a little, assuming oil prices stay right around $80. Right now they’re valued at about 7X forward earnings, and pay a dividend that provides a yield of just under 5%, and if oil prices stay in this range they should have enough cash flow to both increase the dividend and pay down debt further, though their debt burden is already relatively light for a company with huge oil reserves. I can see how this long-lived asset, with no exploration or drilling risk to speak of, should carry a higher valuation… though folks also hate that oil sands appear to be very ‘dirty’ and environmentally intense compared to conventional oil drilling (since it’s effectively more like surface mining — though on a real basis, I don’t know what the fair assessment is of the environmental impact of a fracked well in the Permian vs. an oil sands mine in Alberta).

As of December 31, the 13F says that Elliott still owned only those first 10 million shares of SU that it bought in May, they have not added to the position or sold any, which means they presumably own a bunch of non-disclosed shares in Canada, too (if they were to own 3.4% of the company, that would be more like 45 million shares — I’m assuming they haven’t sold any, since they haven’t gotten the results they wanted yet). Elliott helped to push a management shakeup and now has four new independent board members advocating for change, along with the appointment of a new CFO and CEO (who was last at Imperial Oil, another oil sands operator), so perhaps more improvement will be coming. This is a very large company, with a huge, industrial operating base, so I’m sure change comes pretty slowly.

Not a bad idea if you’re interested in being invested in this oil sands operation… they could do well just by improving their efficiency and catching up with peers on the valuation front, though the biggest driver, of course, will be commodity prices. Food for thought, at least.

What else is Mizrahi touting?

“The second company is one of the largest insurance brokers in the United States — representing 90% of the Fortune 1,000. Institutional investor Starboard Value recently bought over 2 million shares and quickly installed two new directors — both insurance industry veterans with excellent track records. It checks all the boxes — it’s hitting its growth targets, returning value to shareholders with buybacks and generating significant free cash flow.”

That’s very likely to be Willis Towers Watson (WTW), Starboard Value did buy over two million shares of that big institutional insurance broker in 2021, launching an activist campaign to shake up the company a bit… though they’ve since sold a chunk, late last year, so it’s now about 1.9 million shares. It hasn’t been a great success so far, they bought the shares in October of 2021 because it had underperformed the industry for five years but had no real structural disadvantages (this was a few months after WTW’s plan to sell itself to AON for $30 billion failed). At the time, WTW shares were at $244, and Starboard saw a potential for $456 in 2024, based on an expectation that the company could grow its EBITDA to $3.15 billion by then.

Today, WTW has pretty much made a round trip in the last 18 months… it fell as low as $200, but is now back to $237, right about where it was when Starboard started pushing for change. Even if you ignore the billion-dollar breakup fee WTW got from AON in 2021, EBITDA fell in 2022 and is now just over $2 billion — other analysts are less optimistic than Starboard, and see that growing to $2.7 billion in 2024 (for those who prefer earnings, WTW is expected to make $14.54 per share in 2023 and $17.20 in 2024 — which means it’s valued at about 16X current year earnings and 14X next year’s earnings).

That’s not a bad valuation, this is a sector where margins tend to be stable and there is some built-in inflation protection, and the more nimble operators carry much higher valuations than that — and pretty much every company in this space had a pretty “flat” 2022. The one I own is the much smaller Brown & Brown (BRO), and I generally prefer the smaller BRO and Arthur J. Gallagher (AJG), but if you add Aon (AON) and Marsh and McLennan (MMC) to the mix you can see there’s a pretty clear trend of “meh” for the insurance agency/brokerage firms in the 18 months or so since Starboard got interested… that’s WTW in blue in the middle (yes, that’s my BRO down there at the bottom, in orange):

And this is ten years… again, they mostly trade together, but clearly WTW has lagged:

Maybe that lag can be recovered, WTW is larger than most of these guys, but not dramatically so, and it probably has plenty of levers to pull… maybe those will show up in a better environment for these stocks in the future sometime. Part of the problem has certainly been that WTW is a slower grower, they’ve only grown revenues by about 8% in the past five years (vs 40% for MMC, or 85% for BRO), but analysts do think that they’ll grow earnings faster than the group in the next year or two, and the stock is at a cheaper valuation (the others trade at 20-24X earnings, vs. 16X for WTW). It’s easier to buy a company that’s already operating well, but sometimes it’s more profitable to buy the laggard that’s trying to improve… even if the improvement hasn’t quite shown up in the numbers just yet.

And one more:

“Starboard took a position in the last stock in this report as well … and another institutional investor, ValueAct, has invested $1.5 billion. This final company owns one of the most recognizable retail chains in the world, with over 16,000 stores. Charles likes this stock because the company is worth just HALF of its underlying operation … meaning the share price could easily double, and fast, without growing the business at all. This is why Value Act invested $1.5 billion … it’s confident it can at least double its current investment.”

Well, Value Act made that investment, and started pressuring the company, a while back (including a big presentation they released about a year ago) … and it hasn’t yet borne much fruit, though the stock is up a little. This is almost certainly Seven & i Holdings (3382 in Tokyo, SVNDY or SVNDF OTC in the US), which is, among other things, the parent company of 7-11.

Wait, you say, there are way more than 16,000 7-11 stores! And it’s true… but there are roughly 16,000 in North America, so we can make it fit the pitch. And more importantly, Value Act hasn’t own any other real “retailer” in many years, but they have been pushing for the spinoff of 7-11 from its parent company, and apparently have invested roughly $1.5 billion in that effort (it’s not on their 13F, since it’s not a US company, but they did release that public presentation to build pressure on management, and the investment has been widely covered in the press).

Japan has a reputation of being a country that frowns on activist investing, preferring to keep the peace and let large companies act as they like, not necessarily in the near-term interest of outside investors… though that’s been changing a bit over the years, with the big conglomerates in Japan seen as some of the best targets for “value creation” by activist hedge funds from the US. I have no idea if this campaign will work for Value Act (and I don’t know if Starboard Value is involved in this one, I haven’t seen that mentioned anywhere), but it’s probably a reasonably valued company for a large retail conglomerate — and it may well be true that a breakup of the company would “unlock value” and double the share price… though it may also just be a slow slog of trying to improve, the company’s independent directors endorsed the management strategy at their annual meeting last week, and they have made some big investments in growing the convenience store network, particularly by buying Speedway in 2021, and divested some of the non-core retail busiensses (including Oshman’s and Barneys Japan), but, as is usually the case, they haven’t agreed to the more aggressive demands of the activist investors. That hasn’t exactly sent the price soaring at this point, and I haven’t heard a reaction from Value Act since the meeting, but if you’re interested in retailers this one is, at least, a huge brand name and a company that’s hiding under a relatively unknown (at least in the US) corporate umbrella.

Incidentally, this isn’t something Mizrahi talked about… but if it’s Starboard Value you want to follow, the highest-profile investments they’ve presented lately have been Salesforce (CRM), Splunk (SPLK) and Wix (WIX), and they’ve been on an interesting mission in the past few quarters to transform Acacia Research (ACTG) into a publicly-traded acquisition vehicle run by Starboard managers (it used to be effectively a patent acquisition & licensing company in the life sciences, with little success, and they’re keeping some of those assets, but their focus is on new acquisitions)… that includes a refinancing that Starboard participated in at $5.25, and they are likely to double down on in the $3.70 neighborhood as the transition continues, which is pretty close to the current price, so they’ll have a lot of cash to work with. The adjusted book value of the company is still something over $5 ($5.95, they say), as they’ve been offloading some of their legacy assets and building up cash, so it might be an interesting one to follow as they look for smallish acquisitions. Their last financial results press release is here, and their conference call transcript here if you’d like to catch up with that story. They expect to have the “streamlining” of their balance sheet completed by the Summer, at which point they expect to have about $3.50 in cash per share to use in making investments. At $3.70, then, ACTG shares are in some ways a call option on whatever Starboard chooses to focus on with its investments over the next couple years. I haven’t dug very deep into the details, and I don’t know what kind of cost structure they have supporting this relatively small investment fund, but it’s the kind of unusual idea that tends to appeal to me… and I kind of like that there were no questions on the conference call, which probably means not a lot of investors are paying attention.

Any of those up your alley? Have other favorite “smart money” ideas? Do let us know with a comment below… thanks for reading!