HOW I’M POSITIONED.

“A pessimist is one who makes difficulties of his opportunities and an optimist is one who makes opportunities of his difficulties.”

Harry S. Truman

The cardinal rule of sales is ‘always be selling.’ Consequently, if you ask a manager if it’s a good time to invest in their product, you might not get a straight answer. Promotion often overshadows objectivity, and few managers will describe their outlook as anything worse than ‘cautiously optimistic.’

Last month, I talked about my gift for launching strategies at exactly the wrong time (small caps entered a bear market within the fund’s first 100 days). Because of my cautious views, cash has averaged 58% since inception. I suspect this caused many of you to wonder, what’s the rush?

No one can consistently predict the direction of the market and it’s foolish to try. I’m not a market timer, but I’ve never been able to make an informed decision on a security with a blind eye to the economy. I suppose you could buy a homebuilder without caring about the direction of mortgage rates, but I wouldn’t recommend it.

Managers are tasked with navigating all markets and some are more difficult than others. Outperformance comes in two flavors, either going up more or going down less than the market. Both are equally valuable, but investors usually prefer the first.

In the spirit of candor, I was cautious as we entered 2025. Here’s why:

·         Small caps bottomed in October 2023 as markets feared rising rates would trigger a recession. When one failed to materialize, small caps rallied 50% in just over a year. Rally-chasing has never been my forte.

·         Consumer sentiment was dour, considering stocks were at all-time highs. For GDP to grow, consumers have to spend more than last year. Three years of high prices and high borrowing costs have weighed on affordability. Credit card balances hit new highs, unemployment was rising and wage growth slowing. In other words, it’s been a tough time to be a shopper.

·         Bond markets were ahead of themselves, anticipating more cuts in 2025 than the Fed’s own projections. Like an enabling parent, the Fed had bailed out equity investors numerous times since the Great Financial Crisis. Given the implications of new fiscal policies and trade wars, I suspected the Fed would err on the side of caution.

·         Compared to interest rates, equity valuations were high as the S&P 500’s earnings yield was below that of 10-year treasuries. While a negative equity risk premium isn’t uncommon (it was for much of the ‘80s and ‘90s), a P/E of 26 is much higher starting point and leaves little margin for error.

·         Consequently, I decided to deploy our capital at a measured pace and let events unfold. My caution seemed warranted when Liberation Day policies sent small caps down 30% from their November high. It has been less helpful in their subsequent 26% recovery, which was just as rapid.

·         But I would remind readers that the stock market moves faster than the economy. While markets seem to be waving the all-clear flag, I suspect the real economy is still digesting new policies, rejiggered supply chains, and new rules of play. It wouldn’t surprise me if this resulted in some mild indigestion.

WHAT EPIGRAM OWNS

Private partnerships are not required to disclose their positions until assets exceed $150 million. At that point, the SEC requires disclosure within 45 days of quarter-end via a 13-F filing. Because managers have no intellectual property or trade secrets other than their ideas, this information is closely guarded and highly sensitive. It’s also why you’ll never see anyone file early.

For celebrity managers, this disclosure often moves markets. I’m not arrogant enough to think people perceive me as worth copying, nor am I particularly secretive. In the spirit of transparency, I’ve told my partners I would disclose my top 10 holdings each quarter. Here they are as of May 31st.

TICKER NAME INDUSTRY  POSITION RETURN

USD Cash 38.5% 2.0%

IMKTA Ingles Markets Grocery Store 7.5% 0.1%

PLOW Douglas Dynamics Work Trucks 4.0% 40.9%

SEB Seaboard Corp Agribusiness & Transport 3.8% 15.7%

CHE Chemed Hospice Provider/Plumbing 3.8% (16.5%)

SCL Stepan Commodity Chemicals 3.3% 16.5%

DGICA Donegal Insurance P&C Insurance 3.3% 26.7%

NEU NewMarket Corp Lubricant Additives 3.3% 42.3%

NODK NI Holdings P&C Insurance 3.2% (15.1%)

VVV Valvoline Auto Maintenance 3.1% 14.0%

*RETURNS ARE HOLDING-PERIOD RETURNS, NOT YEAR-TO-DATE. RETURNS THROUGH 6/30/25.

Because most of these aren’t household names, I’d like to explain how they fit into my views of the economy.

CASH: Two-thirds of the Russell 2000 has underperformed cash year-to-date. I’ve said previously I think it’s wise to be measured when deploying a new fund, but don’t expect me to hide in cash in perpetuity. When I ran the predecessor strategy, cash averaged 14% from 2020 to 2024. An ability to hold cash allows a manager to be opportunistic, price sensitive and maintain high underwriting standards.

IMKTA: I published a report on Ingles Markets in March. Therein, I describe a company whose operating performance was temporarily depressed by Hurricane Helene, had an attractive valuation and substantial downside protection due to its real estate holdings and cash-rich balance sheet. Weis Markets recently repurchased shares at prices that that imply Ingles is substantially undervalued. C&S Wholesalers also acquired Spartan Nash, who while primarily a distributor, highlights a trend toward consolidation in the industry.

PLOW: Douglas Dynamics manufactures snowplow attachments, and after two exceptionally mild winters, I expected demand to improve. With a largely domestic supply chain and a dividend yield above 5%, I saw limited downside.

SEB: Seaboard raises six million hogs and has been battling negative pork margins for several years (which are improving). Commodity investing is difficult to time, but hog farmers can’t sell pork at a loss indefinitely. Trade wars also tend to be difficult for grain traders and shippers, but priced at just half of book value, I believe the downside is limited. The company agreed and recently announced a $100 million share repurchase. Should the dollar continue to weaken, I would expect Seaboard to benefit.  

CHE: Chemed owns two assets, Vitas, the largest hospice provider in Florida and Roto-Rooter, the largest plumber in the US. A nurse shortage during the pandemic and fewer deaths led to two years of negative earnings growth, which reversed in 2024. I’m attracted to the business because of its long history of growth, attractive returns on capital and low economic sensitivity. It has a debt free balance sheet and has repurchased 44% of its shares since 2006.

SCL: Stepan makes surfactants, the primary ingredient in soaps and detergents. Commodity chemicals are known for cyclicality but Stepan had a consistent double-digit return on equity from 2008 to 2022, yet trade for book value. A natural gas shortage in 2022 and a flood in 2024 have pressured operating results, at the same time as they’re bringing a new plant online to cater to ecologically sensitive customers. It’s an extremely defensive business as sales were down 20% in 2009, but earnings were up. We tend to wash our hands and clothes regardless of the direction of the economy.

DGICA/NODK: Both are mutual insurance companies who raised public equity. This model is fraught with conflicts as mutuals serve policy holders while a public company answers to its shareholders. There’s a long history of mutual insurance companies with public float being acquired. Because only a fraction of the shares are traded, they often command a large premium. Neither are great companies, although Donegal’s operating results have improved recently. NI Holdings has divested under-performing assets, put new management in place and repurchased 20% of its float.

NEU: NewMarket makes lubricant additives and you may be familiar with its competitor Lubrizol. The switch to synthetic oils has benefited additive manufacturers and as fuel economy becomes more important, smaller, hotter engines demand better additives. The company’s growth prospects are modest, but it has good margins and very low capital requirements. It’s repurchased 20% of its shares in the past 8 years. Given its international customer base and base oil as its primary input, it benefits from a weak dollar and falling oil prices.

VVV: Valvoline is the #2 oil changer in the US, second to Jiffy-Lube and was spun out of Ashland in 2017. Americans have their oil changed 470 million times a year and demand holds up in a recession (sales were up in 2009). Valvoline has excellent store growth potential and organic growth due to premiumization and ancillary services. The company sold its Valvoline motor oil business in 2023 and returned more than $1.5 billion to shareholders.

CONCLUSION

This is among my longer commentaries and a lot to digest. But hopefully it reveals how I’m thinking about the economy, what type of securities I’m drawn to (at least at present) and how I plan to navigate uncertainty. I’ve targeted essential products and services like grocery stores, snow plows, protein, and hospice care. None of these rely on a strong economy to do well.

A number of you expressed concern about small caps as an asset class, especially in April. I would point out that managers can add value in both good times and bad, and there’s always opportunity if you’re willing to look for it. Eight of my top ten holdings have outperformed the index year-to-date, which demonstrates the sun needn’t be shining to make hay. While the fund’s total return is modest, it’s only been six months and I aspire to manage your capital well across all market cycles. Thank you for your interest in Epigram Capital.

Sincerely,

Dan Walker