We are providing this interim portfolio update for three reasons: 1) to comment on Lamb Weston (LW), which we are preserving as a 10% portfolio allocation; 2) to add another position to the portfolio, Royal Gold (RGLD), with a 5% allocation; 3) to reduce Diamondback Energy (FANG) from a 10% allocation to a 5% allocation to accommodate RGLD.
Buying opportunity in LW
Shares of Lamb Weston, a global leader in french fries and other frozen potato products, have been under significant pressure since April 4, when the company announced a substantial miss with its third quarter earnings release. In the three trading days that followed the announcement, the shares have traded down approximately 23%. We believe this is an overreaction and maintain the stock’s 10% allocation within the Inflation Protection Model Portfolio.
The primary culprit in the earnings miss was a botched transition to a new enterprise resource planning (ERP) system to one provided by SAP. The company estimated the impact to operating profits at just under $100 million.
While this event was unfortunate, these ERP transitions are notoriously difficult, and it is not uncommon for them to go badly across industries. The process involves a complete overhaul of a company’s data systems. In this case, a disruption in their systems led to problems fulfilling certain customer orders and created additional costs to rectify the situation.
LW management believes the disruptions associated with this event are resolved and will not be a factor going forward.
Operational mistakes like these are a surprise and disappointment to investors, who often dump the shares in frustration, as institutional buyers are slow to react to an uncertain situation. While a negative reaction is warranted given the impact to near-term earnings, we believe it has been excessive. The technological challenges of implementing the new software system are unrelated to the long-term outlook for the business.
For perspective, consensus earnings estimates for 2025 following the announcement have only been reduced by approximately 7%. The decline in the share price represents a significant reduction of the valuation multiple. (Updated portfolio snapshot provided below.)
Again, we are disappointed with this unexpected development, but volatility of this nature often creates opportunity.
Rotating from FANG to RGLD
Separately, we are adding precious metals streaming and royalty company RGLD to the portfolio with a 5% allocation. Similar to Franco-Nevada (FNV), RGLD offers exposure to gold through a diversified portfolio of mining royalties and streams, with less operational risk than direct ownership in mining companies.
Gold has rallied in recent weeks, in response to perceptions that the Fed is mismanaging inflation trends as well as heightened geopolitical risk, especially as it relates to NATO’s commitment to absorb Ukraine. With this escalation of tensions with Russia, we expect central bank demand for gold will only increase given the risk of sanctions and/or asset seizures of other reserve assets such as sovereign bonds.
We are funding the purchase of RGLD with a reduction of the allocation to FANG. FANG has performed well, and we continue to like the investment. The decision is primarily based on equalizing the portfolio exposure to investments that are levered to energy, through FANG and Permian Resources (PR), and gold, through FNV and RGLD. With these changes, the portfolio exposure to each commodity now sits at 10%.
Despite the unfortunate setback in LW, the portfolio as a whole has generally performed well since inception and ahead of the S&P 500.
