Zorea Capital Equity Portfolio 1Q 2025 letter

Fellow investors,

Our performance for the first quarter of 2024 was 8.0% (gross) and 7.2% (net). Our net performance is calculated with our standard fee schedule ‘M’ which charges the highest management fee from our different alternatives but no performance fee. As long-term investors, we emphasize that judging our results over a short period of time is not informative.

*See important performance disclosures at the end of this letter. * 11 months.*

Since inception, our annualized performance has modestly exceeded the underlying earnings growth of our portfolio[1]. While we anticipate this to be the case over the long-term, it is a bit of an anomaly over the short-term with no real long-term impact. We are pleased to highlight that, despite this, the trailing Price to Earnings (“PE”) of our portfolio actually declined since inception. This reduction is a result of some changes to the portfolio that collectively improves its trailing valuation. Beyond lowering the portfolio’s PE multiple, we believe that these changes improve the portfolio’s quality, resilience, and long-term growth prospects.

We have not lived by the excesses going on in the market over the last few years, and we will not die by them should they falter. We are eagerly watching the negative price action in some areas of the market with the hope of finding some high-quality companies at bargain prices, though it still seems a little early for widespread dislocations.

Avoiding biases

As the great late Charlie Munger said “if you make a public disclosure of your conclusion, you’re pounding it into your own head.” Writing these letters subjects us to anchoring bias, escalation of commitment bias, and confirmation bias. Please note that no investment operation has had a perfect success rate. We will not be the first. As such, we reserve the right to change our minds and hope to do so quickly and swiftly when appropriate. We take on no obligation to communicate changes of opinion.

ZCE Holdco EPS growth

In our 4Q 2024 letter, we shared some financial metrics concerning our portfolio. We also indicated that this letter would include a metric that calculates the 'look-through’ growth of our portfolio. We call it the ZCE Holdco EPS growth. The metric tracks how, if our portfolio was a Holding company with subsidiaries, its earnings would grow over time. Over many years, earnings growth is the best indicator of share price performance. Provided we don’t pay high valuations for our securities, our long-term gross performance should be at least as good as our ZCE Holdco EPS growth.

For 2024 our ZCE Holdco EPS growth came in at 14.3%. That means the underlying earnings of our portfolio grew by that amount during the year.

There are number of assumptions that go into calculating this number, which makes it imprecise. We try to lean towards conservatism when making these assumptions. We think of the above number as not exactly precise but approximately correct.

If we can maintain the long-term ZCE Holdco EPS growth of our portfolio near last year’s level of 14.3%, we think our investors will do very well. In both absolute and relative terms. For context[2]:

The S&P 500’s average 10-year EPS CAGR from early 1999 to today is 6.6%.
Including a 2% average dividend yield for the period, this rises to approximately 8.6%.
In 2024, the S&P 500 achieved a 9.2% EPS growth.

Although Zorea’s number for 2024 was quite competitive, as your manager, we are dissatisfied by it. We aspire for that number to be higher over the long-term. Of course, without sacrificing on company quality, defensibility, and valuation. We have our work cut out ahead of us.

The USA Inc Turnaround

A few days ago, we published a letter titled The USA Inc Turnaround: Uncle Sam’s quest to climb out of a deep hole. The letter discusses the US Government’s attempt to rein in spending and balancing the trade deficit. For more context on the topic and potential implications please refer to that letter.

Below we focus on the potential impact of the new government’s policies on our portfolio.

Where does the USA Inc Turnaround leave our portfolio?

As of quarter-end our geographic exposure was: US Equities 66.7%, non-US Equities 27.3%, and Cash/T-bills 6.0%.

As noted in the USA Inc Turnaround letter, we believe we invest in industry leaders that sell essential products and are financially resilient. These companies often increase their market share during economic downturns and can become more valuable afterwards. We believe that drawdowns can improve our results over the long-term. Although market downturns can be difficult to go through, they also provide us with compelling opportunities. We are ok with drawdowns as long as the fundamentals of our businesses remain strong.

With that said, at Zorea we dedicate a substantial portion of our time to learning about and understanding the risks that our portfolio is exposed to. The current events are no different. In this regard, we are in reasonably good shape. Our equity investments outside the US have no meaningful sales into the US that could be impacted by tariffs. Most of our US investments primarily sell domestically, don’t have to reshore production, and provide products/services that are generally essential.

Two areas we are monitoring are (1) federal spending on healthcare, and (2) any potential European counter-tariffs on US manufactured aircraft. These two areas relate to our investments in HCA and RYA. In both we think we are relatively protected but are keeping a close eye.

On healthcare spending. It is possible that federal spending on healthcare will decrease from 2025 levels. Some of these cuts could impact hospitals’ revenues related to Medicaid (15% of revenues for HCA) and the ACA Marketplace (9% of revenues for HCA). However, we believe significant changes from the government are unlikely. First, the administration has clearly stated it will not reduce the health benefits people currently receive. Second, large cuts to these programs would severely affect healthcare availability, which is not in anyone’s interest. Third, there are 96mm[3] people enrolled in Medicaid and the ACA Marketplace, many of whom are voting citizens who do not want their benefits altered.

In our analysis of HCA, we assume modest headwinds from revenue related to those two payer categories. We believe that such potential headwinds would have a limited impact on the company’s earnings over the medium-term. HCA has ways to make-up the potential loss in revenue through market share gains and pricing. It is also in the early stages of a number of operational programs that will likely improve the company’s operating expenses (while maintaining or improving patient experience).

Turning to potential European counter-tariffs on US manufactured aircraft. Ever since Airbus’ creation in 1970, there have been long standing disputes over tariffs and subsidies related to Airbus and Boeing. Despite that, RYA, the only ULCC in Europe operating Boeing aircraft at scale, has the lowest aircraft ownership and maintenance costs in the industry. Currently, there appears to be a diminished political will to rekindle this conflict, given the shared interest of Europe and the US in keeping COMAC[4] in check. We believe the trade war between the US and Europe would have to deteriorate significantly before either side targets the other’s aircraft OEM.

Even if we reach that state, we believe both Airbus and Boeing are relatively protected because they are essential to the national interests of their respective countries. Historically, the host nations of both companies have demonstrated a willingness to protect their national champions from external threats. As it pertains to RYA, our analysis indicates that RYA’s intrinsic value is further insulated from tariffs on Boeing aircraft. For starters, this risk only applies to new aircraft. Second, RYA already has aircraft orders in place extending to 2033. Pre-existing orders are typically exempt from new tariffs. Lastly, the company holds AOCs (Air Operator's Certificate) from several countries, including the UK, Poland, and Malta who (we believe) are unlikely to place retaliatory tariffs on Boeing aircraft.

As we look at our portfolio, these are the potential idiosyncratic risks related to the recent government actions that we can identify – though we keep searching. We plan to keep you informed. Overall, we believe we are relatively well positioned for the current events. In aggregate our exposure is limited, there will be some positive offsets, and we are in a good place to reallocate capital should we find attractive opportunities. That doesn’t mean we will not experience a drawdown.

Alignment

A cornerstone of our portfolio management philosophy is to manage client portfolios in the same way we invest our own capital. At Zorea, we cannot guarantee results, but we can guarantee that we are in the same boat as our investors.

Thank you for your trust.

Yours truly,

Simon Bennaim

[1] We will elaborate on our portfolio’s earnings growth in this letter.

[2] The source for the S&P500 data in this section is S&P Global.

[3] Sources: CMS, Medicaid.gov

[4] Commercial Aircraft Corporation of China.

Disclaimer and disclosures

The information in this presentation was prepared by Zorea Capital LP (“Zorea”). It has been obtained from public sources believed to be reliable. Zorea makes no representation as to the accuracy or completeness of such information. Opinions, estimates, and projections in this presentation constitute the current judgment of Zorea and are subject to change without notice.

Any investment in any strategy, including the strategy described herein, involves a high degree of risk. The description of the approach of Zorea Capital LP (“Zorea”) and the targeted characteristics of our strategies and investments is based on current expectations and opinions and should not be considered definitive or a guarantee that the approaches, strategies, and your investment portfolio will, in fact, possess these characteristics. In addition, the description of our risk management strategies is based on current expectations and should not be considered definitive or a guarantee that such strategies will reduce all risk. These descriptions are based on information available as of the date of preparation of this presentation, and the description may change over time. Past performance of any strategy we employ is not necessarily indicative of future results. There is the possibility of loss, including loss of principal.

Any projections, forecasts, or estimates contained in this presentation are necessarily speculative in nature and are based upon certain assumptions. It can be expected that some or all of such assumptions will not materialize or will vary significantly from actual results. Accordingly, any projections are only estimates and actual results will differ and may vary substantially from the projections or estimates shown. This presentation is not intended as a recommendation to purchase or sell any commodity or security.

Performance information in this document reflects the actual performance of the account established by Zorea’s Chief Investment Officer as of May 1, 2024. Reported net performance is net of all actual trading and other account expenses, reinvestment of all income, as well as Zorea’s fees. Zorea’s fees, as presented here, are composed of our standard fee schedule for non-Qualified Clients, consisting of a 1.8% management fee. Our Qualified Clients may elect from other fee schedules we offer. Qualified Clients who elect a different fee schedule may pay higher (or lower) fees and therefore realize lower (or higher) net returns depending on the portfolio’s performance. The specific fee charged to a client will be identified in the client’s advisory agreement.

Because this account was established prior to Zorea becoming a registered investment advisor, this means the performance results are ‘hypothetical’. Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio.

Index information is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators. Index performance does not include the deduction of fees or transaction costs which otherwise reduce performance of an actual portfolio.

Broader market events will generally have some corresponding impact on our results and the client portfolios managed in accordance with our strategy. For example, if US equity markets rise overall, that will frequently help the performance of portfolios with exposure to US equities, while declines in the overall US equity markets will frequently hurt the performance of portfolios with exposure to US equities. Similarly, increases or decreases in interest rates will have an inverse relationship on bond market prices (higher interest rates generally result in lower bond prices, and vice versa) and also some corresponding impact on the returns of fixed income investments. No investment approach can guarantee a positive return or prevent loss.

Performance results shown are not a guarantee of future results and are not a guarantee or prediction of how any client portfolio will perform.

The information contained in this presentation is provided for informational purposes only, is not complete, and does not contain certain material information about our strategy, including important disclosures relating to the risks, fees, and expenses. The information in this presentation does not take into account the particular investment objective or financial or other circumstances of any individual investor.

This presentation is strictly confidential and may not be reproduced or redistributed in whole or in part nor may its contents be disclosed to any other person without the express consent of Zorea and/or its managing partner.

Zorea Capital LP is a registered investment adviser in the state of New Jersey. We may not transact business in states where we are not appropriately registered, excluded, or exempt from registration. Individual responses to persons that involve either the effecting of transactions in securities or the rendering of personalized investment advice for compensation, will not be made without registration or exemption.

Portfolio Metrics – notes on methodology:

For all companies we use latest reportable information as of the date of the quarter. The numbers are our best estimates and what we use internally. However, coming up with the different numbers requires assumptions and some subjectivity. We try to be consistent with our methodology through time but there is no guarantee of accuracy. We use source documents for our calculations. The growth calculations under this table are a weighted average of the underlying growth of our investments. Some important callouts below.

Revenue per share growth (LTM): only includes our single names (indexes are excluded). For CACC, SYF, and AER, we substitute Revenue growth for Book value growth as we see that metric as more relevant to underlying business growth.
# of Positions: excludes T-Bills.
ROE, PE, and EPS growth: all three of these metrics use ‘earnings’ either in the numerator or the denominator. For the companies that we see GAAP or IFRS Net Income as a good proxy of earnings power, we use that. For the companies where it isn’t, we use the metric we deem most appropriate, which is usually Free Cash Flow or company adjusted earnings, but can be something else. We believe we are conservative when publishing these numbers, but we cannot guarantee that such is the case. Both ROE and EPS growth calculations excludes our exposure to indexes and cash. HCA is excluded from our ROE calculation because the company has negative equity.
PE (LTM, ex-cash & index): This metric represents out calculation of PE of our individual company investments. It excludes cash as well as any index exposure we may have.