2024 April CAD

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0.93% MTD

-0.33% YTD

Caravel Capital April 2024 Partner Letter

Dear Partners,

For the month of April, Caravel returned +0.93% compared to -2.95% for the benchmark (-4.08% for the S&P 500 & -1.81% for the SPTSX).[1] This brings year to date total net return to -0.33% for the fund and 5.38% for the benchmark, respectively.

While we are an absolute return shop, we do pride ourselves on our ability to protect against tail risks in the market. Accordingly, we are pleased with the gains the portfolio produced in April against the backdrop of volatility seen in both stocks and bonds. We had positive performance contributions from 7/10 strategy groups within the book, with no single strategy losing more than 0.40%.

We’d like to mention some investments specifically as we promised we would in our previous letter. A la Ebenezer Scrooge, we will examine one trade from the past, one from the present, and one from the future. We do this both to share insights into how we think with our partners, as well as to share our ideas with other potential capital allocators, as theses often don’t work out if you are the only one that believes in them (if only investing were a hard science...).

Looking Back on our Preferred Share Call

Between May and October of last year, we wrote up a strategy we had allocated meaningfully to calling out a material mispricing in the preferred shares of various Canadian corporate issuers. For more details on why we pounded the table so hard on these, I will refer you to those letters. Here we’d like to highlight how this thesis played out – I’ll use the table we shared in our October letter (Published November 17^th, 2023) for reference.

[1] Benchmark = 50/50 weighting of S&P 500 & SPTSX Composite Indices

Of course, nobody is perfect, and it just so happens we singled out the laggard of this group in that letter to make our point (NA.S), which returned a meager 28% over the next five months.

The reason we mentioned these then, and the reason for our not so subtle victory lap now, is to underscore our primary lens for evaluating investment opportunities and, of almost equal importance, position sizing – Risk : Reward. The fund was substantially allocated to this strategy when we wrote about it last year, representing 25%+ of total capital including interest rate hedges. This had more to do with the downside than the upside. Since then, given the move in the underlying securities, we have reduced our allocation to a much smaller weight, even though on paper some of the issues still have the potential to produce respectable forward returns. Know when to walk away – we have done just that with our solid gains from this trade, and using risk : reward as a guide we feel confident in our chances of doing the same in the future.

Highlighting a Current Standout – Artemis Gold (ARTG.TO)

Beginning in the Summer and Fall of last year, we began to follow the advice of one of our many invaluable salespeople (shout out to Alex Tyszkiewicz at Stifel), who recommended we get up to speed on Artemis Gold. Artemis was at the time trading for around $5.50 a share. For the past several years, Artemis has been developing and constructing Blackwater, a large-scale gold asset in BC, Canada. Despite near record high gold prices and being fully financed to build a permitted asset with robust economics in a top tier jurisdiction, Artemis’ shares were trading at less than half of their intrinsic value (according to those who estimate it professionally).   We should also mention management owns a substantial number of the shares and has successfully built and sold their previous gold company, making investors a sizeable return.  This was enough to get us interested, and we proceeded to conduct extensive due diligence of our own, both directly with the company’s management as well as third party experts and analysts. We determined that the discount in Artemis’ shares was primarily being driven by:

1. A large seller unwinding their position in a relatively illiquid stock, &
2. General skepticism that the company would be able to complete Blackwater’s construction on budget given the inflationary cost pressures of the past 3 years.

This left us with a clear plan of action. First, we needed to make our own judgments about management’s ability to build this mine in accordance with their own guidance, which the market clearly did not believe in.  Second, if we determined they could do that, we needed to time our entry strategically so as not to stand in front of the steamroller of a large seller in the marketplace.

After meeting directly with management, we determined that there was a high likelihood they would succeed with their guidance. In other words, the market was heavily overpricing the risk of a failed construction effort relative to what we thought was reasonable. We proceeded to (carefully) initiate a position between $5.50 and $6.00 per share.

Today, we believe we are part of the way to a realized thesis. Since initiating our position, gold prices are up 15%, junior gold equities are up 20%, and ARTG is up 50%+. While we still believe the shares are undervalued and hold a position in them, we have reduced our allocation and taken some profits as the market has come around to our way of thinking.

High Hopes for the Future – Ascend Wellness (AAWH.US) Term Loan

At the risk of slipping a disc in our shoulders from patting ourselves on the back, let’s finish by talking about an opportunity where all the gains are in the future. We previously wrote about a unique high yield debt opportunity we discovered in Trulieve Cannabis (TRUL.CSE) bonds. We have since had two very profitable kicks at the can with Trulieve, having realized 20+% IRRs in both their 2024 and 2026 bonds, the former of which we bought around $95 within months of them being called at par. Well, we believe we have found a similar opportunity.

Ascend Wellness, like Trulieve, is a multi-state operator in the legal US cannabis market. Due to regulatory and banking constraints as well as self-imposed ESG considerations, Ascend has a limited pool of eligible investors from whom it can source its capital. While this is unfortunate for Ascend (though the tides are shifting in their favour), their disadvantage is our opportunity.

Ascend has just over $300 million of total debt, of which $275 million is in a senior secured term loan that matures in August, 2025 and bears a 9.5% interest rate. The terms of the loan are (unsurprisingly), extremely investor friendly and provide solid protection for the company’s creditors. Ascend expects to do $550+ million in sales, $100+ million of EBITDA and $50+ million in free cash flow in 2024, on top of the $70+ million of cash on its balance sheet and $50+ million of available financing tied to its unencumbered real estate holdings.

We were able to buy Ascend’s Term Loan for ~$95, representing a 13+% yield to maturity between now and August 2025. A 13% yield implies ~900 bps of credit spread on a company who has a net debt to EBITDA of ~2.0x and is growing quickly with a high degree of operating leverage. If this were not a cannabis company, there’s an argument to be made that Ascend should be an investment grade issuer, in which case its credit spread would more likely in the 100-300bps range. As such, we bought the bonds because they offered a very compelling yield relative to its credit risk. If our thesis plays out, we will happily ride out the 13+% return for the next 15 months.

But here’s the kicker – like TRUL, we expect AAWH will call and refinance these bonds within the next few months. If that plays out, our realized IRR will again be 20%+. The company’s trajectory as well as shifting attitudes towards cannabis in the US make us comfortable in estimating the probability of this happening at over 75%. Again, being right on this would be nice, but is not the basis of our investment. Upside, baby, upside.

If you have any questions about our fund, strategies, or just want to catch up, we are available via phone or email at any time.

We thank you for your continued support,

Jack and Glen

Managing Partners, Caravel Capital