Turning Point Brand should have been similar to Swedish Match - It wasn't

Making mistakes and dealing with them

Making mistakes and dealing with them

Turning Point Brand should have been similar to Swedish Match. A quality company with a Free Cash Flow (FCF) Yield of 10%, a strong distribution network and the potential for decent growth.  It wasn't and my position went down 37%.

Here were my mistakes.

Underestimating the competition

One of my biggest positions is British American Tobacco (BTI). I did a boatload of work on it and its competitors. At the same time, I underestimated the competition when there isn't a legal framework protecting you. RAW rolling papers came in and took full advantage of social media. At the same time Turning Points' Zig-Zag was asleep at the wheel. Tradition became staleness. As a result sales from Zig-Zag went down 2% and Wraps 22% -  despite big headwinds from cannabis legalisation. 

It was cheap - but not cheap enough

The last year was fraught with high valuations and mania. As a result my perception of value shifted a bit. Whereas before I was sceptical off anything above 15 PE, that price suddenly seemed cheap. Especially for a company that was growing more than 8% and had 10% FCF yield. But it wasn't. I abandoned my usually strict margin of safety requirements, and as a result paid the price. Additionally now, even if the company grows a fair bit -  it will yield significantly less than BTI, but comes with much more risk. 

Overestimating management

I was never happy that the management tried to break into the "NewGen" of tobacco products like vape. It requires way more capital than the company has access to, and they would be fighting against the giants of the tobacco industry (Philip Morris, British American Tobacco, Altria...). Management always was fond of acquisitions, but instead of buying small brands that are struggling to keep up with the increased FDA regulations, the capital allocation was not great. Now with the new CEO, they talk about acquiring a bigger target -  maybe even outside the tobacco space. For me that is a dealbreaker. One bad quarter can happen, several in a row shouldn't. 

So what now?

My thesis was wrong, and there wasn't enough margin of safety. The only thing that I abided to, was position sizing. At cost, it was a 6% position, so with a 37% decline it caused a 2.22% decline in my overall portfolio. If I would have been more concentrated here, the damage would have been much bigger.

In the future, I will try to protect the downside more. Even in a worst case scenario, the company should offer enough margin of safety for a decent return.