Investing in distressed companies can be very lucrative, provided the right level of expertise and enough research. Distressed companies are working against the clock to stay afloat and are highly risky and investors usually prefer distressed debt instead of equities, because of the downside protection (bonds usually have legal claims on some assets and can receive new securities or cash in a reorganization).
Distressed equities could provide returns well above 100%, but if the company files for bankruptcy or restructures, investors usually get nothing. One fund that specializes in distressed investing is Contrarian Capital, led by Jon Bauer. For over 30 years, Contrarian’s flagship strategy involved finding the best risk/reward opportunities in distressed assets in the US, Europe and Emerging Markets.
Contrarian usually seeks out equity-like returns with the protection rights of a debt holder and capitalizes on all phases of the distressed cycle. In its latest 13F filing, the fund disclosed an equity portfolio worth $1.02 billion. The fund has a lot of exposure to the energy and materials sectors, which together amass over 60% of the equity portfolio value. The focus on coal and commodities such as iron ore and steel, which saw some recovery last year, as well as geographical emphasis on Brazil, which is on a path of recovery from a economic crisis, has helped Contrarian generate pretty handsome returns lately.
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At Insider Monkey, we assess a fund’s returns based on the weighted average return of its holdings in companies with a market cap worth over $1.0 billion that are disclosed in quarterly 13F filings. This measurement is not as accurate as the fund’s actual returns, but it allows us to determine, whether the fund is a good pick to imitate. We are using the data as part of our small-cap strategy, which involves determining the best small-cap stocks that best-performing hedge funds in our database are collectively bullish on. Our strategy has outperformed the S&P 500 ETF (SPY) by over 20 percentage points since it was launched in May 2014 and we share the stock picks with our premium subscribers in quarterly newsletters (see more details here). In addition, we have an activist newsletter, which focuses on one activist fund each month and looks into the best ways to imitate that fund.
Back to Contrarian Capital. As stated earlier, its bets paid off very well last year. For the third quarter of 2017, the fund’s stock picks returned 20.5%, while over the 12-month period ended September 2017, their performance stood at 86.4%, mainly due to 54% and 20% return registered during the third and fourth quarter of 2016. Throughout 2017, Contrarian’s top stock picks also registered positive returns and on the next page, we are going to take a closer look at these stocks.
Peabody Energy Corporation (NYSE:BTU) represents Contrarian Capital’s largest holding. The fund held 4.89 million shares of the company worth $192.65 million at the end of 2017. In addition, the fund also owns almost 2.70 million convertible class A shares valued at $199.96 million. Both positions amass over 38% of the fund’s equity portfolio. Peabody Energy Corporation (NYSE:BTU)’s common stock surged by over 66.50% in the second half of 2017, with the fund having initiated a stake during the second quarter. The coal miner, which emerged from bankruptcy last April, has recently reported a solid fourth quarter, with EPS of $2.47 beating the consensus estimate by $1.12 and reversing from the loss of $9.27 posted for the same period of 2016, while revenue of $1.52 billion inched up by 5.6% on the year and exceeded expectations by $10 million. At the same time, Peabody initiated a dividend of $0.115 per share. However, Peabody Energy Corporation (NYSE:BTU) is also seeing flat growth in seaborne thermal and met coal in 2018.
From a sector perspective, Peabody Energy Corporation (NYSE:BTU)’s future is rather uncertain. Despite the new White House administration promises to save coal, its prospects in the West don’t look good. The International Energy Agency forecasts that the global coal demand will increase slightly trough 2022, due to growth in Asian countries, but China is looking into ways to phase out coal and last year cancelled plans to build over 100 coal-fired power plants. More demand might be expected from India, which is expected to increase its steel output, and it will be the main growth driver for coal.
Paul Singer’s Elliott Management is the largest institutional shareholder of Peabody Energy Corporation (NYSE:BTU). In a 13D filing disclosed earlier this month, Elliott disclosed holding 35.34 million shares of the company, which is equal to around 34% of the company’s outstanding common stock.
Vale SA (ADR) (NYSE:VALE) is the third-largest position in Contrarian Capital’s equity portfolio. During the fourth quarter, the fund added 713,272 shares of the Brazilian iron ore producer and disclosed a $96.22 million stake containing around 7.87 million shares in its latest 13F filing. Vale SA (ADR) (NYSE:VALE)’s stock surged by 60% last year as the company enjoyed higher iron ore prices, which resulted in revenue growth of 64% on the year in the fourth quarter of 2016 and 59% in the first quarter of 2017. Last year, Vale SA (ADR) (NYSE:VALE) saw record iron ore production of 366.5 million metric tones, up by 5.1% compared to 2016. In 2018, the company expects iron ore production of around 390 million metric tons.
Another shareholder of Vale SA (ADR) (NYSE:VALE) is Arowstreet Capital, led by Peter Rathjens, Bruce Clarke and John Campbell, which disclosed ownership of 29.73 million shares as of the end of 2017, down by 43% over the quarter.
Another winning pick in Contrarian Capital’s equity portfolio last year was Braskem SA (ADR) (NYSE:BAK), a Brazil-based producer of thermoplastic resins. Last year, the company settled a lawsuit from US investors alleging that it concealed its role in the corruption scandal involving state-owned oil company Petroleo Brasileiro SA Petrobras (ADR) (NYSE:PBR), which is one of Braskem’s owners. In addition, The Wall Street Journal reported in October that LyondellBasell Industries NV (NYSE:LYB) approached Braskem SA (ADR) (NYSE:BAK) about a potential acquisition in a deal that would value Braskem at more than $10 billion, but the company denied the report the following day and Odebrecht, the other co-owner of Braskem, reaffirmed the intention to keep the company in its portfolio.
Among the top shareholders of Braskem SA (ADR) (NYSE:BAK) are – Phill Gross and Robert Atchinson’s Adage Capital Management and Jim Simons’ Renaissance Technologies, which hold 5.43 million shares and 4.08 million shares, respectively.
Last, but not least, Contrarian Capital added Caesars Entertainment Corp (NASDAQ:CZR) to its equity portfolio during the fourth quarter and amassed 3.39 million shares worth $42.92 million. In October Caesars Entertainment Corp (NASDAQ:CZR) emerged from a three-year bankruptcy, which resulted in the spin-off of its properties into VICI Properties Inc (NYSE:VICI), a REIT, from which the new Caesars Entertainment Corp (NASDAQ:CZR) will lease its properties. The exit plan also involved bringing certain assets under the control of the company through its merger with Caesars Acquisition Corp and other affiliates and creditors hold most of its stock. Caesars Entertainment Corp (NASDAQ:CZR) emerged from bankruptcy with $9.6 billion in debt, versus $25.6 billion it had before bankruptcy and plans on expanding its Caesars, Harrah’s and Horseshoe brands both in the US and in other countries.
Another investor that is betting big on Caesars Entertainment Corp (NASDAQ:CZR) is billionaire George Soros’ Soros Fund Management, which disclosed holding 34.50 million shares of the company, with the $436.41 million stake being its second-largest in terms of value.
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