Soaring Success: How Aerospace Investments Have Propelled CAMX in 2024

The Cambiar Aggressive Value ETF (CAMX) has gotten off to a strong start in 2024, up 7.95% through 4/30, besting the 4.33% of the primary benchmark, the Russell 1000 Value, and slightly ahead of the 6.04% for the S&P 500 index. As we reflect on the first third of the year, Cambiar President and CAMX Portfolio Manager Brian Barish, took some time to sit down and answer some of the most popular questions we’ve received from the field.

Click here to view the current holdings and the latest performance for the Cambiar Aggressive Value ETF

Brian, to get things started, for those who may not know much about the Cambiar Aggressive Value ETF (CAMX), how do you manage the strategy and what makes it unique?

The Aggressive Value ETF is a concentrated, large cap value strategy. We will hold anywhere from 15-30 securities at a time and not more than that. Given the concentration, it certainly cannot be represented in all parts of the stock market; the smaller number of holdings means that we need to pick our spots. I look for stock ideas generated at Cambiar by our research team or myself where the valuation, support, and upside case are particularly strong. For any stock that Cambiar buys, we have a “base” upside case, and as well there may be more of a “blue sky” upside case. A blue sky investment case happens when a variety of assumptions about the future develop favorably – so much so that one could not ordinarily have expected so many good things to happen. Broadly speaking, investors don’t count on blue sky investment cases to unfold very often; the base case is far more probable. But they do sometimes, and understandably lead to better returns.

For CAMX, the stocks chosen tend to be ones where I think the blue sky case has a much better chance of happening than one might suppose. That might not be true for every stock in the portfolio, but it is the case for most. Even so, one must understand that blue sky investment outcomes are, by definition, infrequent. It’s kind of like shooting a 3-point shot in the NBA, where a 40% shooting percentage is considered “good”.

How do you manage position sizes?

Typically I start things out at about a 3% position, which is similar to our more traditional Large Cap Value strategy. Then, depending on how events and financial performance evolve, the position may be scaled up to 5%, or even a bit beyond. Running a concentrated strategy with large positions requires care! I have found that scaling positions up over time, rather than taking a gigantic swing of the bat so to speak, is the better way to manage things.

We are over a third of the way into 2024, what positions have driven performance?

So far it has been a big year for aerospace-related positions. Tech and Energy have been the other major contributors.

In aerospace, the setup in late 2023 was actually rather favorable in terms of low embedded expectations and valuation. The hangover from COVID, which decimated industry profitability like nothing before it, has continued to leave a considerable mark on the space. Airline operations are still recovering. Aircraft and related parts production were deeply scarred and still has not returned to 2019 levels. Nonetheless, carbon mitigation and overall global growth implies strong demand for newer and more efficient capacity. That all means varying degrees of pent-up demand to me.   I also suspect these kinds of names struggled in 2023 due to the persistent negative noise around an imminent inbound recession that has yet to materialize.

By early in the first quarter, we had built up four aerospace-linked positions in Delta Airlines, RTX Corporation, Airbus, and an aircraft leasing company called AirLease.

For Delta, we concluded this is the best run of the “legacy” U.S. carriers. For many years, legacy carriers have lost market share to low-cost carriers (LCCs), such as Southwest or JetBlue Airlines, because legacy carrier costs tend to be fixed/inflexible, unlike LCCs. However, as these LCCs have become big national-scale operations, their cost advantages have waned. Meanwhile, with labor costs exploding almost everywhere you look, perhaps the shoe is on the other foot, so to speak, and legacy carriers’ more rigid cost structure may actually help! That’s kind of wild thinking versus the experience since the 1980s, but we have not had inflation nor persistent labor shortages like this either. Delta has appreciated but remains far from a blue sky target. Getting there would take years, not quarters however. Lots of proving still to do.

Airbus, which we have owned for a few years in this strategy, is a good example of a blue-sky investment outcome. The blue-sky case (going back several years) involved reaching a dominant industry position and taking significant market share versus Boeing, with mini-monopolies in certain popular aircraft sizes. Something like this is happening, as Airbus is poised to dominate the narrowbody aircraft market for the next decade.

That is not because they have been so brilliant but because their only rival has been breathtakingly dumb. No doubt you have heard about Boeing’s problems with the design of the 737 MAX and other manufacturing quality issues. I’ve been following this competitive duopoly for years, back when the current generation of new engine technology planes were still in the design phase. This included the 737 MAX, which is a re-engineering of a now 60-year-old aircraft design. The 737 MAX was revealed as a new design in 2011. At the time, I could not believe Boeing would try to squeeze what are very wide-diameter engines under the wing of a very low-to-the-ground plane. It just did not fit! However, Boeing did not want to endure the R&D expense of a complete redesign. It seemed like certified lunacy, and you had to wonder what else this said about Boeing’s engineering and cost-avoidance culture.

Net, my blue sky case was that Airbus might succeed in owning far more than the 50% of the narrowbody market that they had controlled up through the mid-2010s, cementing a dominant position in a strategic industry. It has been a long and rather dark road to see that vision of things pan out, but Airbus may very well own 70% or more of the narrowbody market prospectively. Narrowbodies are >85% of all daily flights around the globe; a dominant position is indeed very valuable. We have pared back the Airbus position in 2024, as much of this is reflected in the stock price. But we still think there are more cards to be dealt in this story.

That’s pretty interesting. So you are saying you saw corporate ‘rot’ at Boeing based on this one product design decision in 2011?

More or less, yes.

You mentioned Energy as another major contributor. How does that jive with decarbonization in aerospace? What is the thinking there?

The Energy sector, investment into it, and valuation are beset by a number of false and misleading narratives. The problem is one of excessively optimistic and pessimistic narratives about global supply and demand, the impact of electric cars, how much green energy sources can be counted on, and so on.

Here’s an example of incomplete thinking:

What would constitute a “successful” reduction in crude oil consumption in the United States? What other things in the world might offset this?

The USA currently consumes 20.7 million barrels a day of oil, a level that is about unchanged over the last 8-9 years. That equates to 21 barrels a year per citizen. Per our International Energy analyst Robbie Steiner, the most successful reduction in per capita oil consumption in an advanced country in the last 80 years is Japan, where oil use is 9.7 barrels per year per citizen, which is down about a third versus prior highs. Japan achieved this via extensive investment in electrified mass transit, more efficient cars, more efficient industry, etc. Japan is also a much more physically dense country than the USA. Let’s say the USA reduced per-citizen oil consumption by 25% in the next 20 years, and that population growth is very modest. That would conceivably knock down 4-5 million barrels a day of demand. But over on the other side of the globe, India consumed 4.4 mm bpd in 2023, or 1.34 barrels of oil per capita per year, up 8% from 1.24 in 2020. There are more than 1.4 billion people in India and the population is still growing considerably. What are the odds India grows to 4-5 barrels a day per person by 2044? We would say the odds of that are high. Far higher than declining to 1.0 barrels a day. Assuming the population tops out at 1.6 bn (which seems low versus the trend), that would take India’s consumption to 8 billion barrels a year, or 22 million barrels a day. This will more than offset the reduction in USA per capita oil consumption. India is huge but not alone. The same forces prevail in any number of Asian countries and most of Africa. Chinese oil consumption is about 3.3 barrels per capita. They are doing a lot with EVs and other forms of non-oil based transportation. But it is still challenging to see Chinese demand as poised to decline from here; if anything I would also expect it to rise another 50-100% as more Chinese consume, travel, and so forth. Even if they use a lot of electric cars…

What you are saying is there is a bit of a math problem, yes?

Yes. It’s a math problem. There is an expression that goes “a realist is an optimist with a calculator”. That’s very relevant here. There are similar math problems with concepts such as electric trucks, electric aircraft, and how much biofuel can be provided by agricultural production and waste products. I hate sounding like a curmudgeon, but for the moment there seems to be a very limited case substituting fuel sources. Which means that global oil demand is likely to be resilient into the visible future.

OK. How does that translate into energy stock picks?

There are plenty more myths and happy talk to deconstruct. If we can table that, our view is that oil prices will fluctuate in a “normal band” between $60 per barrel on the low end and about $85 on the high end. Commodities do have blowouts in both directions outside of normal price bands. Natural gas in West Texas went below $0.00 earlier in 2024 for example, as they ran out of storage at the end of winter! For oil, we suspect the market will “lean tight” relative to that range over the next several years, as limited upstream investment entails supply growth does not reliably keep up with demand. If you follow that line of thinking, oil prices will probably have sporadic “tail events” on the right side of that range, i.e. superspikes well over $85 to ration supply and encourage drilling. By definition tail events cannot easily be predicted in advance and are not sustainable, but we suspect they will happen more frequently. Particularly if shale oil production growth in the United States tops out in the next year or two. That would probably take the sustainable oil price range higher.

Interesting. But will energy stocks get credit for future superspikes?

No, not superspikes. What’s interesting to me as an investor, is when stock prices embed assumptions about the future that are unrealistically low. For energy stocks, most oil majors’ stock prices embed long-term oil prices at the low end of that range, or about $65 per barrel. That’s where the long-term oil futures curve happens to be, and this is not any different from discounting today’s ~$80 per barrel out a few years using the current 5.5% Fed Funds rate as your discount rate. To me, this says the futures curve does not contain much in the way of future price expectations – it’s just an extrapolation from today. In general, commodity futures contracts don’t tell you very much about the future. In the interim, with present-day prices that lead to strong returns on investment/high ROEs, most energy companies have relatively high share repurchases and will just keep at it. So, as an investor, one can compound the market’s excess pessimism. That is provided that the management of these energy companies act prudently and grow their production and reserves at a modest pace over time.

What is a blue sky investment case then?

Blue sky outcomes can happen in one of two ways. One way is that the stocks start to discount much higher long-term oil prices, especially if shale growth “tops out”. We see that as quite possible in 2026 and beyond. I see that as a “holy cow” kind of event that could really shake up a lot of stocks and asset classes. Alternatively, let’s say energy stocks never get credit for $80+ oil. Stock buybacks at really low multiples of normal earning power are an amazingly effective way for investors to compound their capital in this situation. Your per-share oil production, cash flow, dividends, etc can grow far faster than global oil growth. Our current roster of oil producers (Chevron, Canadian producer Cenovus, and Italian major ENI) all manage to grow production & reserves, pay dividends and buy back shares, and embed unrealistically low L.T. oil prices. I call them “PGRECs”, or Production Growth and Reserves at low Capex. No that’s not very memorable.   We can just hang with these PGREC stocks for a long while – that’s how I look at it. You might not realize it, but energy majors have been better overall performers since late 2020 than the FAANG / MAG7 stocks. That’s what compounding will do for you.

That sounds really dark Brian with respect to environmental goals and such.

I know. Look, I’m not in charge of public policy. If I was given king-of-the-world powers, there would be an across the board carbon tax with no exceptions. If you want less of something, tax it with no escape valves. There would also need to be well-priced tax credits or outright cash compensation for negative carbon, such as industrial scale carbon capture and sequestration, re-forestation, and so forth. And then I would go hard-nuclear for our power grid, and standardize the design of micro-nuclear reactors for a reliable and scalable power grid. Over time you let markets and human ingenuity figure out solutions, not politicians running for election every 2-4 years.

None of this will get me elected for so much as a dog catcher let alone Congress. Some of the above, but not nearly enough, needs to persist in public policy, and needs to catch fire in the global South where far more people live. I am not able to be optimistic about either of these right now. Sorry, that’s just where I come out. One should direct anger at Pollyanna solutions to global warming as promoted by politicians and (so-called) think tanks, and not to oil companies specifically.

What has not worked thus far in 2024?

Healthcare stocks have lagged the most. We are not giving up on these. There are clear inevitabilities with respect to healthcare demand that will persist. It seems to me there is a massive divide between growth-y haves and value-y have-nots across the board, from drug companies to healthcare services to device companies. It may be as simple as letting time do the work for us – as companies grow earnings even modestly, it will be hard to hold stocks such as Medtronic, LabCorp, and Centene down with free cash flow yields approaching those of oil stocks (though it is not quite as bad as those). I don’t have a clear time frame for when these will become less bedraggled than they currently are, but there is plenty of upside, even in a base case, let alone a blue sky case. I think the market finds these kinds of names to be as boring as whole wheat toast right now compared to  AI stocks and cloud computing. I like boring sometimes.

How do you feel about the stock market for the rest of the year? Does the election factor into your thinking?

Going to give a cliché answer – I expect the market to fluctuate, which means I really have no clue. It seems like there are both expensive and cheap stocks out there to me, at least for now, so I am not overly concerned. An election has been scheduled for November 2024 since some time in the late 1700s, so it’s very hard to take so-called “election uncertainty” seriously. Based on simple political analysis, it seems very unlikely that the Democrats will remain in the majority in the U.S. Senate. I think that removes most extreme tax-and-spend scenarios from the table. We are likely headed for some national belt-tightening with a (truly terrifying) level of fiscal spending that needs to be reined in. This probably won’t be very popular, but that’s a different topic for a different day.