August 19, 2022
Dear Unitholders of Chou Associates Fund,
The net asset value per unit (“NAVPU”) of a Series A unit of Chou Associates Fund at June 30, 2022 was $134.85 compared to $142.25 at December 31, 2021, a decrease of 5.20%; during the same period, the S&P 500 Total Return Index decreased by 18.56% in Canadian dollars. In U.S. dollars, a Series A unit of Chou Associates Fund decreased by 6.84% while the S&P 500 Total Return Index decreased by 19.97%.
The table shows our one-year, three-year, five-year, 10-year, 15-year and 20-year annual compound rates of return.
| June 30, 2022 (Series A) | 1 Year | 3 Years | 5 Years | 10 Years | 15 Years | 20 Years | |
| Chou Associates Fund ($CAN) | 5.0% | 10.9% | 4.2% | 7.4% | 4.3% | 6.0% | |
| S&P 500 | ($CAN) | -7.3% | 9.9% | 11.1% | 15.6% | 9.9% | 8.2% |
| Chou Associates Fund ($US) | 1.2% | 11.5% | 4.4% | 4.9% | 3.0% | 6.9% | |
| S&P 500 | ($US) | -10.6% | 10.6% | 11.3% | 12.9% | 8.5% | 9.1% |
Rates of return are historical total returns that include changes in unit prices, and assume the reinvestment of all distributions. These annual compounded returns do not take into account any sales charges, redemption fees, other optional expenses or income taxes that you have to pay and that could reduce these returns. The returns are not guaranteed. The Fund’s past performance does not necessarily indicate future performance. The table is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values of the mutual funds or returns on the mutual funds. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing.
Factors Influencing the First Six-Month Results
The largest increase in the period were the equity holdings of Exco Resources Inc. The Canadian currency depreciated against the US dollar, which also positively affected the Fund.
During the period, the Fund reduced its holdings in MBIA Inc., JPMorgan Chase & Company and Bausch Health Companies Inc. The preferred shares of Overstock.com, Inc. were converted into common stocks.
The Fund did not make any new investments or enter into any foreign currency contracts in the first half of 2022. The Fund sold a few covered call options on the equity holdings of Resolute Forest Products Inc. during the period ending June 30, 2022.
Portfolio Commentary
Resolute Forest Products Inc. (RFP, Financial) (“RFP”)
As of June 30, 2022, the market price of RFP was US$12.76 per share. Having said that, it is quite comical to us how a commodity stock can be hammered beyond all logical comprehension. RFP paid a special dividend of US$1.50 a share in 2018, and it was trading as low as US$1.17 per share in April 2020. Back in March 2020, the company announced that it would buy back 15% of its common shares for US$100 million. At the lowest price of US$1.17, the whole market capitalization would be approximately US$99 million. In other words, instead of buying back 15% of the company with US$100 million, it could repurchase 100% of the company. RFP shares have since recovered a very healthy 990.6% to US$12.76 as of June 30, 2022.
The investment in RFP goes to show you what it takes to have the mindset of a value investor. I wrote about it in the 2021 annual letter, but it’s worth repeating. “When the stock is that cheap, assuming that you don’t own any shares, a rational investor should back up the truck and buy every share that is offered in the market. But what makes it difficult for some investors to buy is not the rational side of their mind but more the psychological aspect of it. In the stock market, you are bombarded with noises that affect a person’s rationality. It can get radically altered. Stock prices can move unrelated to the fundamentals of a business. During a bull market, you may see several stocks trading at anywhere from 50 times to more than 100 times earnings, and conversely, there can be several stocks that sold at 10 times earnings going down to below five times earnings. The fundamentals of the company are ignored and, instead, investors are transfixed on the price movements of the last couple of years. Then new narratives are written most convincingly on why these are the “new” paradigms, and why they are not worth giving weights and considerations to what the assets are worth and what the company can earn over several years. I remember talking to one value manager in 1999 when the tech stocks were in full bloom. He said, “I have a family to feed and I will keep losing assets if I don’t accept the new headlines and paradigms. Sticking to buying companies that are undervalued is not the way to be successful in the long run”. He changedhis philosophy before the tech stocks were about to go into a severe decline over the next couple of years.”
“In spite of the price of RFP trading at US$15.27 per share, it is still quite cheap. Let us look at a few facts. The shares may be able to get back close to US$400 million in duties (approximately US$5 per share), but the earning power over the next two years is most likely to be more than US$3 per share annually and the lumber prices may stay elevated for a while because there is an imbalance between supply and demand in housing that may take a few years before it comes back into equilibrium. Meanwhile, it is making money hand over fist.”
Since June 30, 2022, RFP announced that Domtar will be purchasing the company. The transaction will be carried out by way of a merger between RFP and a newly created subsidiary of Domtar, providing for the conversion of each share of RFP common stock into the right to receive US$20.50 per share, together with a CVR (Contingent Value Rights) entitling the holder to a share of future softwood lumber duty deposit refunds. Each share, on a fully diluted basis at closing, will be entitled to receive one CVR.
What it proves is that in investing, an accurate valuation of what a company is worth matters the most.
Bausch Health Companies Inc. (BHC, Financial) (“Bausch Health”)
In early August 2020, Bausch Health announced that it is planning to spin off its eye care business, Bausch + Lomb, into an independent publicly traded company. This will allow the company to concentrate on its gastroenterology, aesthetics/dermatology, neurology and international pharma business.
If Bausch Health had spun off Bausch + Lomb when it was announced in 2020, we would have made a healthy gain; but the two-year delay has considerably eroded the prices that Bausch Health could have fetched for Bausch + Lomb.
In hindsight, it was a mistake to wait for the spin-off of the Bausch + Lomb unit. At the time, we felt this would have been the much-needed catalyst to get Bausch Health to trade closer to $40 per share.
In consolation, in 2021 and the first half of 2022, we were able to sell approximately 61% of the shares that we had in Bausch Health for an average price of US$24.30 per share. In addition, we received close to US$8.00 per share in premiums for writing covered call options on some of the shares.
EXCO Resources Inc. (EXCE, Financial) (“EXCO”)
In early July 2019, the company emerged from bankruptcy and the 1.75 lien term loans were converted to 28.38 equity shares for every US$1,000 in par value, after netting out certain adjustments. The equivalent price was US$9.51 per share of EXCO.
Since it is a private company, I am not at liberty to divulge the latest financial statements but what I can tell you is that my calculation of its PV-10 value was approximately US$1.5 billion (roughly $30 per share) based on New York Mercantile Exchange (NYMEX) forward pricing as of December 31, 2021, and the net proved reserves was 2.6 trillion cubic feet equivalent. The value for PV-10 is considerably higher for June 30, 2022 and can be roughly calculated if one uses the New York Mercantile Exchange (NYMEX) forward pricing for June 30, 2022. Its number of shares outstanding was 51,341,478. We estimate that its EBITDA for the year ending 2022 will be approximately US$225 million.
As a comparison, in 2018, the PV-10 value was US$750 million.
Although a substantial portion of EXCO’s oil & gas production is hedged for the year 2022, we believe that EXCO can fetch much higher prices as the hedges have started to roll off.
Caution to the Investors
Investors should be advised that we run a highly focused portfolio, frequently just three to five securities may comprise close to 50% of the assets of the Fund. In addition, the Fund has securities that are non-U.S. and could be subjected to geopolitical risks, which may trump or at least negatively influence the financial performance of the company. Also, we may enter into some derivative contracts, such as credit default swaps when we feel that the market conditions are right to use those instruments. Because of any or all of these factors, the net asset value of the Fund can be from time to time more volatile than at other times. However, we are not bothered by this volatility because our focus has always been, and continues to be, on how inexpensive we believe the Fund’s portfolio holdings are relative to what we believe to be their intrinsic value.
Other Matters
FOREIGN CURRENCY CONTRACTS: None existed at June 30, 2022.
CREDIT DEFAULT SWAPS: None existed at June 30, 2022.
U.S. DOLLAR VALUATION: Any investor who wishes to purchase the Chou Funds in U.S. dollars may do so.
REDEMPTION FEE: We have a redemption fee of 2% if unitholders redeem their units in less than 3 months. None of this fee goes to the Fund Manager. It is put back into the Fund for the benefit of the remaining unitholders.
INDEPENDENT REVIEW COMMITTEE: The Manager has established an IRC as required by NI 81-107. The members of the IRC are Sandford Borins, Peter Gregoire and Joe Tortolano. The 2021 IRC Annual Report is available on our website www.choufunds.com.
As of August 19, 2022, the NAVPU of a Series A unit of the Fund was $ 150.75 and the cash position was approximately 13.1% of net assets. The Fund is up 6.0% from the beginning of the year. In U.S. dollars, it is up 3.2%.
Except for the performance numbers of the Chou Associates Fund, this letter contains estimates and opinions of the Fund Manager and is not intended to be a forecast of future events, a guarantee of future returns or investment advice. Any recommendations contained or implied herein may not be suitable for all investors.
Yours truly,
Francis Chou (Trades, Portfolio)
Fund Manager
