Cove Street Capital First Half 2022 Letter to Shareholders

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GREETINGS DEAR SHAREHOLDER:

TOTAL RETURN (MUTF:CSCAX) — % as of June 30, 2022

3

MONTH

Year to date

1 YEAR

3

YEAR

5

YEAR

10 YEARS

CREATION

(09/30/98)

Cove Street Capital Small Cap Value Fund

(1:70 p.m.)

(12.36)

(12.89)

0.32

1.77

6.52

8.82

Russell 2000® Index

(17.20)

(23.43)

(25.20)

4.21

5.17

9:35 a.m.

8:15 a.m.

Russell 2000® Value Index

(15.28)

(17.31)

(16.28)

6.18

4.89

9.05

8.67

The performance shown for the period to 20 January 2012 reflects the performance of the CSC Small Cap Value Fund, a series of CNI Charter Funds, the predecessor of the Cove Street Capital Small Cap Value Fund (“the Fund”). The Fund has the same portfolio manager and substantially similar investment strategies as the previous fund. The Institutional Class began trading on October 3, 2001. Institutional Class performance results reflect the performance of Investor Class shares from December 31, 1998 through October 2, 2001. The Investor Class subsequently closed on November 25, 2015. .

Performance data quoted represents past performance. Past performance does not guarantee future results. Investment returns and the principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Actual performance may be lower or higher than quoted performance. For up-to-date performance data through the end of the most recent month, please call 1-866-497-0097.

The gross fee rate according to the Prospectus is 1.22%. The Fund charges a redemption fee of 2.00% on shares sold within 60 days of purchase. Performance data does not reflect redemption fees. If so, the yield would be reduced.

While some might say “things have changed in the world”, the most accurate reading in our view is that “Silly”, as expressed in financial markets over the past few years, is beginning a long lag and, in our view, long lasting. reversion. Take your pick – Crypto Currency “Investing” (i.e. Fraud), outrageous valuations applied to unprofitable new ventures, political investing with no practical basis in reality, “private” versus public investing, large cap versus small capitalization. In summary, we believe that this “change” has just begun, is not far from complete and is only just beginning to reveal its magnitude.

While we can’t claim there hasn’t been or will be more collateral damage to funds like ours, we suggest the following: pay lower valuations and prices today for real businesses – with real “sustainable” futures, as defined by real products and services that customers will continue to want and can be sold profitably – is a BETTER view than there are 12 months – or 3 months. To some extent, we “ensure” that prices go down so that we can buy more of what is good and reasonably priced.

As for the details that we focus on most of our time, we have Blueknight Energy Partners (BKEP), second time around was a bit of a charm. In late 2019, the Ergon family, the general partner of Blueknight Energy, made an inadequate bid to acquire the remainder of the business and simplify a complicated ownership structure.

Within months, the offer was withdrawn because Ergon was unable to reach an agreement with the company’s conflict committee. That’s when we got involved and subsequently built a position. Recently Ergon made an improved offer which we consider to be “fair at best”, but we are always happy to reserve a good return.

Hallador Energy Company (HNRG) is a… (get ready)… coal company. They have an unusual asset position – a very low cost base in the Illinois base – almost all of which is thermal coal used in power generation. You may have noticed that the United States is theoretically trying to squeeze our electricity needs into a 10-year plan when in reality 50 is probably the realistic number. Pursuing this unrealistic goal produces a severe shortage of “baseload” electricity generation, which is simply not a good thing.

Our bet is that Hallador’s assets are worth much more and will generate cash for much longer than the market expected. There is an interesting and financially savvy board that guides the CEO. In a new and interesting twist, the company is essentially getting a coal-fired power plant in its backyard due to political issues. This could represent a huge upside potential subject to the vagaries of regulations and weather. Although we have been following the company for many years, this was a new purchase during the quarter.

White Mountains Insurance Group (WTM) is a holding company that has been sometimes in and sometimes out of the portfolio for… 30 years. They mainly invest in insurance and fintech. We’ve been very good at determining when they’re ‘dormant’ or ‘active’, and the stock tends to mirror pole-to-pole movement. We shrewdly recognized that their decision to invest over $600 million in reinsurer ARK last year was a key sign of “asset,” and we had a 5% position within days. ARK has done well as global prices remain high.

While the market tends to value WTM at book value, we struggle to understand that many of their assets are worth far more than book value, such as their recent sale of NSM underinsurance at nearly 4 times book value. . The business is cheap and stable, and the managers are good stewards of our capital.

Viasat Inc. (VSAT) seems to be either our biggest winner or our biggest loser every quarter – boring. The much-delayed launch of the first of three next-generation satellites will take place at the end of this summer, and this event should end this yo-yo in stock and set us on a more sustainable path in the eyes of the world. Oh, and we think the defense sector alone is worth almost twice the current stock price.

Compass Minerals International Inc. (CMP) also appears to be a similar model to VSAT. It is the portfolio company that has been hit the hardest by ‘inflation’ – fuel and transport costs – as it prices its de-icing contracts once a year – and therefore a portion of the profits of 2022 has been swallowed up by most of what you read in the newspaper. The good news is that pricing is an annual event – ​​and we’re very confident that next year’s pricing will reflect inflationary pressures and margins will be restored. The stock is absurdly cheap.

Lions Gate Entertainment (LGF.A, LGF.B) is in the process of splitting off into Starz and the legacy studios business, essentially undoing the merger that occurred in 2017. Upon announcement of the sale or the potential split from Starz, the stock appreciated significantly. There had been a definite perception that the Lions Gate management team was not interested in creating shareholder value and would never sell the whole company or any part of it.

This change in narrative was helpful until Netflix (NFLX) announced its first quarter 2022 results, which pretty much sank the entire video streaming industry. The first concern was Netflix’s inability to develop domestic subs. The other takeaway was that Netflix would reduce its spending on content. Despite Lions Gate selling very little of its content to Netflix, there was concern in the market that studios, like Lions Gate, which are essentially arms dealers to other platforms, were going to see a precipitous downfall. demand.

The stock price has fallen to a level that currently represents a fraction of our conservative estimate of intrinsic value, and management has suggested a deal for Starz could be in place by the first quarter of the calendar year. 2023. Vivendi, Roku (ROKU), Apollo (APO) and DirecTV (DTV) would be interested in acquiring part of Starz. But regardless of the buyer, our research suggests a deal is likely to create value for shareholders, especially relative to the currently depressed share price. In the meantime, it’s been quite heartening to see director Gordon Crawford continue to buy hundreds of thousands of shares on the open market.

We recently initiated a position in InfuSystem Holdings (INFU), a leading provider of ambulatory infusion pumps which are primarily used to deliver chemotherapy drugs to patients, taking advantage of a large block of stock offered in the market at discounted price. INFU’s core pump business is growing at a steady market rate of 1% to 5%, and the company is now using the cash flow generated from this business to enter adjacent segments.

A natural extension is INFU’s Biomedical Services business, which has seen significant growth. The company recently entered into a major agreement with GE Healthcare to manage its fleet of over 300,000 infusion pumps. Additionally, in early 2020, INFU partnered with Cardinal Health (CAH) to create a Negative Pressure Wound Therapy (NPWT) business, which they recently launched. The price we paid for the stock reflects a fair value for its underlying core pump business, and we get a free option on the value created by any additional business, including NPWT.

In closing, we reiterate what we said in the introduction. We find it hard to argue with the long-held notion that buying decent businesses run by reasonable people at reasonable prices is not a rational process in which to invest money for the long term. What IS hard is sticking with this process when the world gets messy. We STRONGLY suggest a process we call “leaning into the wind” – operators standing by.

By the way, we try – not always successfully – to minimize the taxes paid by shareholders. Therefore, at the end of a given quarter, you might see movement in the portfolio that reflects these attempts.

Cordially,

Jeffrey Bronchick, CFA | Main | Portfolio Manager Shareholder | Cove Street Capital Small Cap Value Fund


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% as of June 30, 2022

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Ecovyst Inc (ECVT)

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Compass Minerals International Inc (CMP)

4.84 %

White Mountains Insurance Group Ltd (WTM)

4.22 %

Wayside Technology Group Inc (WSTG)

4.13 %

Enovis Corporation (ENOV)

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Legacy-Crystal Clean Inc (HCCI)

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Lions Gate Entertainment Corporation CL B (LGF.A, LGF.B)

3.39 %


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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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