TIP770: Mastering the Markets w/ Andrew Brenton

28:26I also just can't help but think about Florin Decor is a great business, But in the 2010s, it has had this massive tailwind at its back. Being a hardwood flooring company, they are very much tied to the housing market. So if real estate prices are going up, if interest rates are going down, this is a major tailwind for flooring decor as a lot of homeowners go and refinance, do a home equity line, get some capital to go and redo parts of their home. And I think that a lot of the investment case today is that the housing market or the hardwood flooring industry is near a cyclical low and there's a lot of pent-up demand that's going to eventually be unlocked as the market rebounds.

29:06I just checked prior to this interview, the operating income for Flooring Decor has gone from just shy of$400 million in 2022 to$256 million in 2024. I have this natural bias against trying to avoid many cyclicals just because I just never know where we're at in the cycle. So talk about how you think about where we are at in the cycle for Florin Decor to ensure that we're not entering a value trap. I think of value trap as basically getting things wrong on our forecast. Florin Decor is a company that's never going to issue equity. They're not at the point of returning capital to their shareholders because they have such a runway for growth and can take all of their capital, even at this lower rate of earnings, and redeploy it into geographic growth.

30:02And the last time we spoke to the CEO, I did ask him, when are you coming to Canada? Because I recently did a renovation and I know how expensive it is for stone and slate and tile and understand the value prop that they provide. I don't believe in value traps if you've done a full model and you've done your best and you own companies that don't need a high share price. And then when they have surplus capital, they return it to their shareholders. And I think the reason why, as we found Florin Decor and did work on it, that the reason we own it is all of the things you just said. If you have the ability to think long-term, to look past this, frankly, profoundly weak environment we're in, in North America.

30:55I think that what we talked about earlier, the AI wave and the hyperscalers and the megaprojects and the data centers are clearly, I think, covering up quite a weak economy away from that. It was interesting, when we spoke to management, I guess a few months ago, maybe six months ago now, they've taken their new store build for 2025 down twice. And we asked them, well, in what situation will you regret that decision? I think they went from 30 to 25 and then 25 to 20. And they said, well, if we come out of this recession with a V recovery rather than like a U recovery. And so in their world, they've been in a recession for a number of years.

31:43And as you say, Clay, there is pent up demand since the great financial crisis and the housing bubble, then household formations have been profound, new home builds have not been. And so there is pent up demand, There is no question about that. But we've got the timeframe to not really worry about is it going to happen in six months or a year or in three years. Because if you own the company in an industry that's just structurally advantaged, as Florin Decor is, and they're taking share from their competitors, they're still growing, as you say. They've doubled their store count over the last few years.

32:25And the point they made to us is, well, we've taken our store openings from 25 to 20. But by the way, we've acquired the land, we're building those stores, we're just not staffing them and putting inventory in them until next year. So it is still a high growth company that is taking share from competition. And we don't spend a lot of time thinking about, well, when does the turn happen? We're looking out five years, 10 years plus, that's our focus. And I think because of that, there are a number of companies that have made it into our portfolio in the last three years because of the fact that the economy in North America is soft, and they're more impacted by that.

33:11And so the share prices have gotten to the point where we're able to say, if you have a long view, these are now cheap enough to make it into our portfolio to push other things out. And Florian Decor is a good example of that three years ago. Yeah, I mentioned interest rates there and the low interest rate environment that fueled the real estate market. And now, of course, we're in a slightly higher interest rate era. How does recent interest rate cuts and just your outlook on the US housing market, how does that play into the thesis on floor and decor? In a way, it doesn't, right? Because this is a company with net zero debt.

33:48And even in this soft environment, they're making lots of money. So that thesis might play into where's the share price going to be a year from now, but it doesn't play into what's our view of the intrinsic value of the shares. So the macro environment is not a big factor in how we think. But let me be clear, if you gave us two companies that are equally attractive, well-run, one of them's floor and decor, one of them is a non-cyclical business. With the same cheapness, we would have more of the non-cyclical business. So we're not afraid of cyclicals like floor and decor, but we do titrate down how much we would like to own versus something that is non-cyclical.

34:36Like we own a US company called SS &C, and they are very non-cyclical. So at the same cheapness, we'd have a lot more in SS &C than we would in floor and decor, but they're not at the same cheapness today. So it's in our thinking, but it's more we think about, well, what's the impact on their industry and what's happening to their competitors? I mean, one of their large competitors has filed for bankruptcy or did last year, sometimes the weak economy for a company like Florandercore can actually be a positive if you're thinking out long enough, because it's taking their competitors who don't have the same business model, it's taking them out of the market.

35:21And it just gives them greater share in five plus years when the economy is much stronger. Robert Leonard It's a classic case of many mom and pops simply being undercut on price. And these new stores are being built across the country and stealing share from many of these smaller players that just are structurally disadvantaged. You mentioned being very valuation focused. How about you talk a little bit about the valuation of floor and decor and in general, what sort of discount to intrinsic value you're looking for in your portfolio additions? Sure. I mean, so when we say intrinsic value, you can think of it as what's the present value of all future free cash flows back to shareholders at about a 10 % rate.

36:06We've never played with that discount rate. When we started, rates were higher than they are today. And of course, rates for a long time went close to zero, as you mentioned. And now they're back to what I think of as a more normal environment. If you have a very long view. So we've never changed our discount rate on our companies because of changing interest rates. And so when we talk about intrinsic value, that isn't where we think the shares should trade. And when people have share price targets, we don't have targets. We just say there's a huge range over which Florindecor could trade and it would be very defendable, right?

36:47people can always come up with a reason why it's trading where it is today. And as you mentioned, the share price has been north of 120. Now it's back today, a little below 60. They're both fine. Those are reasonable prices. Our view of intrinsic value is well above 120. But that doesn't mean we think it should trade there. I mean, in a very rough way, You could think of it as the takeover price of a company. Not that we think anybody's going to step up and offer a huge premium for a floor and decor. It's just not that kind of target. So what we do is we say, the bigger the gap between the intrinsic value and the share price, adjusted by a bunch of aspects of a company like cyclicality, just as I mentioned, we just have a target waiting for each holding.

37:41And it's higher today than it was a month or two ago when the share price was actually quite a bit higher than it is today. And nothing's changed in the business. If something did change, if there was a new entrant and some structural change was occurring in the industry, we'd really focus on that. But none of that's happening with Florin Decor. it's a very strong management team with some new additions and some recent very logical changes for executive management. So I think everything's good in the company, if you know what I mean. And so we just let the noise of the market wash over us, and we take advantage of that noise to do somewhat better than a long-term buy and hold.

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42:08That's shopify.com slash T-I-P. All right, back to the show. So as you mentioned, you're a very valuation-focused investor, I believe. the typical stock in your portfolio is around a PE of 11 or so. You love cheap stocks. But when you look at Florin Decor, its headline PE is actually around 30, which leads me to believe that there's going to be some adjustments that need to be made here. And you could also probably make the case that this might be a higher growth name relative to some of your other holdings. How do you think about making adjustments to the earnings of a company like Florin Decor, if any, in this case?

42:47I mean, it's company by company. And in the case of a pure organic growth company under US GAAP, it's not bad, right? There are some of our companies, we own a lot of what we call platform companies that they make acquisitions and then the accountants under the accounting rules, you no longer amortize goodwill, but you put them in buckets of customer customer lists and things, intangibles, which doesn't make any sense to me, and then that impacts earnings per share. So there are some companies that you really have to make sometimes some pretty material adjustments to the gap earnings, or in our case in Canada, IFRS.

43:28But in the case of Florin Decor, the gap earnings are not too bad in terms of a number. And it's funny, you mentioned 30 times, I had it in my head that it's more 40 to 45 times. So you're right, you've got a high growth company, and we have a lot of high growth companies, but then we own some 10 % earnings growth companies over the next five years plus, and we own them because they're trading at a single digit price earnings multiple. And so it is a mix. But if you recognize that the earnings for floor and decor, they're obviously depressed at this point in time. So if you thought about a normalized number, it's lower.

44:12And then if you think about the growth they have for probably for decades, it ends up being cheap. But we never think about the multiple in terms of our decisions. We do have these large financial forecasts and financial models. And so when we quote 10 or 11 times for the portfolio, we're just trying to find a way to communicate how attractive the portfolio is, opposed to saying, that's how we value companies, if you know what I mean. Robert Leonard Leonard Excellent. Well, let's get to Kinzel Capital here. This is another stock in the portfolio that's fairly well known by our listeners. So this is a specialty insurer that's been successful in its strategy to grow in the excess and surplus market.

44:58They only have around 1.5 % market share in their industry. And that share has doubled over the past five years. And one of your statements that stood out to me in one of our first interviews was how you're looking for one-of-a-kind unique companies. And I think Kinzale certainly fits that description. Actually, I previously worked in the insurance field. So I saw firsthand how slow and archaic some of these companies in the space can be even when a highly disruptive player like KenZale steps into the industry. And this is another very high growth company. You look back at previous years, many years they grew top line by over 40%.

45:36Currently, they're growing around 20%. How has the story and thesis on KenZale developed since we last spoke last year? In terms of develop, just everything is as we expected. And as we get to know companies better, we either rate them higher or we de-rate them. And it goes both ways, right? The more time you spend with management. In the case of Kinsale, I sometimes joke, we deal with companies, we follow them, we try to follow them closely, we speak to them when we can, trying to be respectful with the fact that they're running a company, almost in a way of waiting for them to say something stupid.

46:16Kinsale has never said anything stupid to us. And so that idea of it is what we look for, a highly intelligent company in a fairly mature market, although especially in excess, that share is growing from the regulated market. And as you mentioned, they're taking share in that market. It's not just that they have a profound cost advantage, which they do. I mean, you can think of it as much as as a technology company as it is an insurance company. And it's tough to imagine their larger competitors saying, hey, we should rip out our systems and do what Kinsale did from scratch. It's really hard to imagine that happening.

47:03And so they do have a meaningful cost advantage. But also, I think as an organization, they're just really good underwriters. They're thoughtful. And I'm not an insurance expert by any means. Our approach is to find a highly intelligent company, and then you learn the industry from them. We know insurance a little bit at times. We've owned Fairfax Financial, which many people would know, terrific insurance company based here in Toronto. So we learn from the company. And when you watch how they dial back their exposure, when you ask them about large policies like multinational corporations, what they explain is you probably don't want to underwrite that because they're big enough to self-insure.

47:52And so they're really just testing, are you willing to give them a policy at a cheaper price than they're willing to write internally? So their focus is small and medium-sized businesses. It's just, we've learned so much from them about their industry, and it just continues to impress us. So, as I mentioned, we have all these aspects of a company that factor into our weightings, away from just the intrinsic value, and whether it's management, business quality, which often is the management team has created the business quality. Kinsale gets really high marks, frankly, across the board. And so it's better than when we last spoke, I guess is the way I would put it from our standpoint.

48:38And you mentioned looking out at least five years, I mentioned the market share today. Here in the US, they have around 1.5 % market share. They have around 2 billion in revenue and$130 billion market. So certainly room to continue to capture more share. Do you have a level of market share in mind that either the management team is looking forward to capturing or you guys are looking at? Or how do you think about how much room there is for them to grow into this market? I mean, that is the key question, right? With a high growth company, with that kind of structural, self-created structural advantage.

49:17I mean, their expense ratio is much lower than the competition. And as I said, they're really good underwriters. So it's a terrific combination. Will they be 5 % market share at some point? I think it's inevitable. Will they ever be like Lloyd's of London that our best guess is at 17 %? I think Kinsey would say, that would be a bad thing. You don't want to be that much of the market. So again, it's a thoughtful approach from management. If the market is soft, because we had a hard market. And as you say, they were growing top line premiums, written premiums at 40%. It's lower now. That's self-induced because they're not going to write bad business.

50:02And as an example, in the commercial property space, at least in certain regions in the US, they drastically reduced their policies written a couple of quarters ago. Because they said, like there's new competition who are going to lose money on these policies and we won't compete on that basis. So I think part of it is the market share will partly be determined by the competition. So they're not saying, oh, we want to be 10 % or 6 % or 5%. They just want to write good business. And last year, they announced their first ever share buyback authorization. organization. And people in the insurance industry, when we talk about Kinsale, say, oh my God, they're looking at buying back shares at five times book.

50:50And they think the way we do, well, by the way, they bought very little stock so far, but they say, well, there's book value, and then there's intrinsic value. And if we can buy our stock at a discount to the intrinsic value, that creates value for our shareholders. And so they're at the point now where because their returns on equity are so high, when they're not growing at 40%, they end up generating surplus capital. And that just adds another arm to the story, if you will, from being overwhelmingly fixed income in their float to now feeling like they can have an increasing amount of equities at the right time.

51:33Not sure right now is the right time in terms of, for example, the S &P 500, but also adding the idea of buying a bit of themselves if the share price is attractive. And look, if you can find companies like that, you know the share price is going to be higher in five years and in 10 years. And from our standpoint, I hope the path is jagged. So far, we've only owned Kinsale for two years. It's been a very jagged journey in terms of the share price if you pull up a chart. And that's good for us. What we love are low intrinsic value volatility. And just a bonus is high share price volatility. I remember the first two quarters after we owned the company, the first quarter, they reported for us kind of what we were expecting.

52:20The stock was down 20%. I don't know why. We bought more stock. And then the next quarter, the results were for us in line, and the stock was up 20%. And so that's a nice thing for us. We embrace that as opposed to a steady Eddie share price. Robert Leonard I think you hit on a couple of really important points in relation to Ken Zale and the insurance industry overall. Insurance can have some very irrational players. Buffett and Munger have talked about this for years where some insurers will, for whatever reason, get excited. and want to write unprofitable business just to grow the top line.

53:01And that's when a company like Berkshire or a company like Ken Sale is going to take a step back and let them pursue some of that unattractive business. And then there can be periods where there's just opportunities everywhere to write business. And that's when they can step in. And you can just really appreciate a manager that recognizes opportunities when they present themselves and not playing the quarterly EPS Wall Street game of, oh, we need to hit our quarterly numbers. So we need to write this business to grow the top line or grow the EPS short term. The repurchases, I think, is also worth highlighting there.

53:33The first time they're doing share repurchases. And as we know, the management team knows the business and knows the intrinsic value as well as anyone. So share repurchases are certainly a very good sign for a company as well-run as this. Look, I mean, at the end of the day, it's what I mentioned earlier, we own companies that are never going to issue equity. We started this conversation talking about efficient markets and the purpose of the why is it important that markets are efficient. It's capital allocation. But the other thing to understand about the public market is that good companies are public for a bunch of reasons.

54:13Often the original owners, it's a road for them to diversify their own portfolio, whether it was a family business. And so we own companies that are self-funded companies. They just happen to be public. And Kinsale's a really good example of that. They are so profitable, the debate as we go forward will be, well, how much capital do they have that will get returned to shareholders? I think of companies like that as slow motion management buyouts. The number of companies that in our portfolio are over the years who have said to me, either the share price is a lot higher in three years, or you and I are going to own the whole company.

54:56So if you have companies like that, it's the classic, The Outsiders, that book by William Thorndike, who it's a terrific profile of eight companies that have just knocked the cover off. And one of the attributes they have is really being focused on capital allocation. And it was interesting when I first had dinner with Thorndike, and this is years ago now, he said, you know, Canada seems to have a disproportionate number of these outsider companies. You know, he mentioned Couchtard out of Quebec and others, which may be true. And maybe it is the less of a aggressive Wall Street mentality here in Canada that allows those companies to be more outsider companies.

55:42I don't know. But yeah, if you find a company that thinks about that they're not going to try to be a Berkshire Hathaway, they're going to stay as a pure insurance company. And they're going to, as they have more surplus capital, at the right time, shrink the share count. Because it's funny, we think about share buybacks. There are a lot of groups or people who can criticize share buybacks versus, let's say, dividends. We think of it as, well, why wouldn't you take your surplus capital and buy 100 % of the shares from your shareholder who has the lowest opinion of what you're worth? And that's how we think about buybacks, and good companies think the same way.

56:24Preston Pyshenko Before we close it out here, I wanted to give you a chance just to talk about some of your recent performance. Because when we look back at the history of your firm, you've had different periods of outperformance and underperformance. And today, you're in a period of underperformance, which really shouldn't be a surprise given the developments with AI. And I know that you likely haven't flinched at all with regards to sticking with your strategy. And I'd just like to give you a chance to reflect a bit on the importance of sticking with a strategy when it's going against you, because all great managers are going to go through those periods.

57:00It's just an inevitable part of being a stock market investor. Yeah, for sure. I mean, it's funny, as you were asking the question, it reminded me of someone, and this is a long time ago, who commented to me when we went through a bad patch within our first decade. And he said, it's a good thing you had those great early years to know that what you do works. And I said, I didn't need to have a few good years to know that owning high quality companies, management and boards that are focused on shareholder value over the long term, that I didn't need to have some decent results to know that that's the right approach.

57:38And the same thing applies today. So yeah, we're lagging on a mark-to-market basis. It's one of the reasons that, well, it's the main reason why we actually print a change in intrinsic value. How we feel like we're doing based on the companies like Florin Decor and Kinsale, we didn't take our value up on Florin Decor by 100 % when the share price doubled. We didn't take it down by 50 % when the share price fell back down to where it is. It's been never a perfect steady progression, but it's company by company trying to communicate, hey, this is how the portfolio is doing. The economy has been a headwind for some of our companies.

58:19There's no question with floor and decor, that's the case. With Kinsale, it's not economically cyclical, but as you were describing, it's industry cyclical. You have a hard market and a soft market. It's not so much the shape of the economy, it's a new entrance. And then there are three hurricanes that are devastating in one season, and all of those new entrants leave. So every company has its own character. And so from an increase in intrinsic, it's business as usual. And one of the thoughts or terms, statistics, in an investment world is something called active share. And we have an active share of 97.5%.

59:03We look nothing like the indices. I mean, if it was compared to the S &P 500, it would probably be an active share of 99.9%. So what we do is we own a collection of high quality companies at any point in time at the most attractive valuation from the companies we follow. And you made the comment. It's inevitable, especially in the environment that we're in, that we're going to lag. It's happened to us before and guaranteed it's going to happen at some point in the future. Yeah. Well, not to make a statement about your future performance, but I think just looking at in general, when you look at a number of great managers, when the market is just roaring and some of these great investors aren't faring as well, I think that can be a sign of where we might be at in the cycle.

59:53Certainly not a forecast, but always interesting to look back and compare and contrast how things end up playing out. But Andrew, as always, I thoroughly enjoy having you on the show and appreciate you sharing your thoughts on the market and discussing a couple of your holdings. Before I let you go, how can the audience learn more about you and Turtle Creek? Well, we have a website, but importantly, it's.ca, not.com, because we're Canadian. And And yeah, there's plenty of information there, especially if you click that you're an international investor. Not that I'm suggesting that you should do that.

1:00:30And then if it is a US resident, someone on the team will reach out and you get a code and you have full access. We've got a pretty good website with all of our communications and lots of information. We've written, I think, some decent stuff over the years and it's all there on the website. Thanks again, Andrew. I really appreciate it. Thank you so much. This was fun.

1:01:20Thank you.