Sohra Peak Capital Partners Q2 2023 Letter To Partners

Dear Partners and Friends,

Our partnership recorded a gain of +17.1% net of all fees, expenses, and allocations for the quarter ending June 30, 2023. Over the same period, the S&P 500 (SP500, SPX) recorded a gain of +8.7% including dividends.

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The below table highlights the partnership’s key portfolio composition metrics as of June 30, 2023:

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I am happy to report our partnership’s second quarter gain, and to also report that for the third quarter our partnership has been off to a good start. As readers are likely aware, over the first half of this year, the general stock market has harvested the lion’s share of its gains through a small handful of mega-cap darlings. While many small-cap stocks have struggled to gain traction in this environment, we have continued to perform well thanks to the strong performance from many of our long-term investments made over the quarters and years prior.

As I have communicated in past letters, particularly during periods of strong returns, I think it is important to impart a reminder that in our pursuit of delivering exceptional long-term returns, I also expect our returns to be volatile along the way. This is true for any strategy predominantly invested in equities, and is especially likely to be true for us, given our exposure to small-cap and micro-cap equities as well as fluctuations in foreign currencies. History has also shown that the share prices for even the best long-term performing businesses are almost certain to experience unpredictable bumps and snags, and we are well aware that our companies will not be immune. With that said, to date, we believe our willingness to withstand short-term volatility has been worthwhile, and has reinforced our longstanding view that volatility is the friend of the long-term oriented investor.

As I have also mentioned, and which I believe cannot be overstated and bears repeating, the full credit for our capacity to adopt a long-term oriented investment approach would not be possible without the confidence and trust of our excellent limited partners. It is our partners who enable us to adopt a long-term view of our holdings, which I firmly believe to be a competitive advantage in this business, and which in turn should continue to serve our partnership well over time. I would like to extend a thank you as well to the many prospective partners who have reached out in recent weeks, all of whom have been a pleasure to speak with, and a number of whom have already expressed interest in joining our partnership. If our current partners have in mind accredited investors who might align well with our partnership, or if any prospective partners wish to learn more, we are currently open to new introductions.

Reflecting on Two Years

A little over two years ago in July 2021, I founded Sohra Peak Capital Partners with not much more than my own capital and the conviction that our partnership could deliver outstanding investment returns over the long-term. Looking back over these past two years, there have certainly been many lessons learned from both an investment standpoint and a business standpoint, and my experience has been no exception to the axiom that all long-term business progress occurs in a non-linear fashion. However, above all, I still feel just as eager and curious to practice investing each day as I have ever been, an essential ingredient which I trust will remain unchanged over the years and decades to come.

Among the investment mistakes of commission and omission that I have made, and believe me there have been plenty, one concept which I have recently given a lot of thought to is my historical tendency to trim the position weightings of our portfolio winners by too much, and too early. In more instances than not, those winners have continued onward to become even bigger winners, and our partnership as a result has not benefitted as much as it should have.

The main elements that have created the dilemma of whether or not to trim on a handful of occasions have been chiefly twofold. On one hand, our investment approach seeks companies that we believe to be of high business quality and management quality with the ability to grow free cash flow per share at high rates for many years. When our companies of this type have met or exceeded our expectations, their share prices have in some cases appreciated meaningfully, and within a short period of time.

While this is by all means a terrific outcome, the other consideration that has occasionally entered the equation has been the element of risk management, which includes assessing portfolio concentration and valuation. All else equal, if a company’s share price doubles in a short period of time, it is now almost double its initial position size while also being twice as expensive as when it was initially purchased. This is the inverse direction of portfolio sizing that one should feel comfortable with from a purely logical standpoint, given that all else equal, the company’s shares offered higher upside appreciation and lower downside risk initially before doubling in price.

It can also be true that if a 10% portfolio holding trading at 10x trailing free cash flow quickly becomes a 20% position trading at 20x trailing free cash flow, aside from portfolio concentration considerations, there may still be every reason to maintain one’s portfolio weighting in the company. For instance, if the company’s forward-looking profit growth prospects are thought to be durable and compelling enough, paying 20x current free cash flow may still prove to be far below intrinsic value, and refraining from selling any shares would be the correct call.

In addition to monitoring portfolio concentration, which has at times been a real consideration, I have also been generally biased towards owning businesses with lower trailing free cash flow multiples – today we only own two businesses trading at over 15x our estimate of Owner’s Earnings – almost regardless of the company’s potential growth prospects. In my view, this provides built-in protection to help minimize our downside risk in case I should be materially wrong in my analysis of the company’s future. Upon reflection, I believe it is this bias which has led me to exerting perhaps too much caution over our winners to date.

The most clear example of trimming our winners by too much and too early has been our premature, intermittent trimming of our ownership in Mader Group (OTCPK:MADGF). As longtime readers of our partnership’s letters know, we first acquired shares of Mader Group upon launch in July 2021 at AUD $0.95/share. Shares have since appreciated by an astonishing +689% to AUD $7.50/share. We were right, and in a big way(!), but unfortunately have not participated in the full reasonable extent of gains that we potentially could have.

In late 2021, there were shares of Mader Group that I had sold due to managing portfolio concentration, which are shares that if put in an identical situation I would still sell today. In the quarters since, though, I’d continued to intermittently trim our position, given what I viewed as an increasingly rich valuation multiple, which today stands at 39x trailing P/E or far above that of our typical holding. I had also held a dash of hope that perhaps the stock price would retreat and present better buying opportunities for us to reload our position. The rest has been history, as Mader Group has continued to smash expectations, its share price has continued to climb, and, should the company continue growing anywhere near its recent EPS growth rate of +50% for the foreseeable future, it is hard to argue that its multiple of 39x P/E isn’t justified.

At the 2004 Berkshire Hathaway annual meeting, Buffett and Munger recounted the story of how they missed out on accumulating shares of Wal-Mart years ago, which shares a similar lesson:

“I set out to buy 100 million shares of Walmart, pre-split, at about $23. And Charlie said it didn’t sound like the worst idea I ever came up with, which is, from him, I mean, it was just ungodly praise. And then, you know, we bought a little and then it moved up a little bit. And I thought, ‘Well, you know, maybe it will come back’ or what. Who knows what I thought? I mean, you know, only my psychiatrist can tell me. And that thumb sucking, reluctance to pay a little more, the current cost is in the area of $10 billion.” – Warren Buffett, 2004 Berkshire Hathaway Annual Meeting

We still own Mader Group, and while I wish that I had held on to this winner for dear life a little bit more forcefully, the good news is that this learning can be applied many times over to the current and future gems that we will seek to buy and hold. Peter Lynch, one of my favorite investors, once remarked that, “Selling your winners and holding your losers is like cutting the flowers and watering the weeds.” Going forward, all else equal, I intend for our watering can to gravitate closer to the flowers.

Portfolio Updates

Our partners are encouraged to read our commentary on our partnership’s top 5 holdings in Appendix A attached to the end of this letter.

Earlier this month, we released an investment memorandum on one of our portfolio holdings American Coastal Insurance Corporation (ACIC) which can be found here. Since we wrote this memo, American Coastal has released its Q2 2023 quarterly results, which we found to be quite positive and which has led to an increase in our net income estimates for FY23 through FY25.

During the quarter, American Coastal’s average premium price per new policy written was significantly higher than I had expected, even in spite of the hard market environment. Based on my estimates, this could result in gross written premium (GWP) for the 12-months ending 6/1/2024 of $750MM or greater, and even possibly closer to $800MM, versus the expectations that I had laid out in the memo of $700MM. Furthermore, based on the company’s continued expected premium price increases, GWP should increase yet again for the 12 months ending 6/1/2025, which may also end up higher than my previous estimate.

We continue to view American Coastal as an unusually compelling investment today, and believe that shares could appreciate by +100-200% from today’s prices over the next 2-3 years.

Closing Thoughts

Thank you for taking an interest in our latest letter. I am excited about our partnership’s future.

I remain confident that our partnership’s north star will always be to compound our capital at the highest rate of return responsibly possible. In some respects, this approach may render our partnership uninvestible by many institutional investors. That is perfectly fine by me. We will continue to accept as partners only those who understand, and who are aligned with, our objective.

If you wish to learn more about the partnership, please feel free to reach out to me directly. Our partnership currently welcomes introductions to new investors who are aligned with our philosophy and our long-term approach. Accredited Investors interested in receiving future letters can also register on our website at Sohra Peak Capital Partners.

I value the trust you have placed in me to invest your hard-earned capital, as the substantial majority of my own wealth is presently invested alongside yours. I look forward to writing to you again next quarter.

Most Sincerely,

Jonathan A. Cukierwar, CFA

Manager of Sohra Peak Partnership LLC, the General Partner of Sohra Peak Capital Partners LP

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