Would you please share your thoughts on valuations for the market and the Fund?
Based on long-term interest rates and current inflation, one could argue that the market is currently undervalued. However, with many remaining uncertainties over additional government stimulus, the U.S. presidential election, and elevated unemployment, we believe the market looks fairly valued albeit with a wide range of company and sector valuations that are hard to explain. Importantly, we remain constructive on the market and excited about a portfolio of conviction-weighted holdings of above-average businesses at below-average prices.
The Focus Fund is currently trading at 16x our estimate of cash earnings for 2021 compared to the approximate 20x 2021 operating earnings for the S&P 500® Index. The Fund holds a number of positions we believe are significantly undervalued, including Encore Capital, trading at approximately 4x our estimate of 2021 cash earnings, and insurance company Markel Corp., trading at 8.5x our estimate of its 2021 change in book value per share.
Where are you finding opportunities today?
Today, most industries have seen demand substantially recover and are trading at or near all-time highs. However, a few industries remain severely impacted by the pandemic (e.g., travel and leisure). For some businesses, the market appears to be discounting a very long return to normalcy, a view that is far too pessimistic in our view given that it is likely an effective vaccine will be widely available by mid-2021.
While the market appears willing to ascribe ever-increasing multiples of sales to technology businesses with recurring revenue, many businesses with less near-term visibility trade at very low multiples of normalized earnings. It is in these pockets of the market where we believe the best opportunities lie.
Did you make changes to the portfolio during the third quarter?
We made two notable changes to the portfolio during the quarter.
We purchased Allegiant Travel, an ultra-low-cost airline, and the ninth-largest airline in the U.S. While airlines have historically been poor investments due to high fixed costs, little differentiation, and high cyclicality, we believe Allegiant’s business model separates it from other airlines. Allegiant operates in a niche market for leisure travel, flying from underserved small cities direct to leisure destinations including Florida, Las Vegas, and Phoenix. The company focuses on maintaining low costs to provide fares 40% to 50% lower than other airlines.
We believe domestic leisure travel will be the first area of air travel to rebound, allowing Allegiant to recover its lost earnings power and resume its plans to expand from its current 500 routes to a number more than double that over the next decade. At 8x its 2019 EPS earnings, Allegiant appears significantly discounted compared to its historical average of between 12-18x.
We funded the Allegiant purchase by selling our remaining position in AMETEK, an electronic instruments, and electromechanical device manufacturer. We believe the company had reached its fair valuation and that future growth may not be as strong as in the past.
How has the pandemic affected the market for both used cars and car repairs?
We have seen a substantial uptick in the used car market since the beginning of the pandemic. Used car sales by franchised dealers were up 22% from a year earlier in June, and prices rose by 6% over the same period. A number of catalysts have been driving this trend including an increase in demand for private vehicles due to social distancing and a decline in the use of public transit, a lack of new cars due to temporary auto production closures, and increased uncertainty over jobs losses and future economic conditions.
We believe this trend is also buoying the aftermarket auto parts and repair industries. While the quarantine measures have reduced the overall number of miles driven, a leading demand driver for aftermarket auto parts, it only declined approximately 5% for blue-collar workers, a demographic more likely to repair their cars. The result is that do-it-yourself customers, with a decline in spending on large, discretionary categories like travel, entertainment, sporting events, and restaurants and increased time at home, have had increased opportunities and budget to work on their vehicles. For example, O’Reilly Automotive, a top holding in the Fund, saw same-store sales increase 16.2% year-over-year in the second quarter.