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Income Strategy 4Q 2022 Letter

In the fourth quarter of 2022, the Miller Income Strategy returned 11.68%, while the benchmark ICE BofA US High Yield Index was up 3.98%. Someone in the active management industry recently said to me, “I don’t know, I have a hard time envisioning what takes the market higher from here. Inflation is driving down multiples, the Fed is withdrawing liquidity, and we are staring a recession in the face, which is apparent from the heavily inverted yield curve.”

Much of this may be true, but the market is a discounting mechanism, which means it is the future that matters, not the past. One method for dealing with an ambiguous future is to imagine oneself in a year’s time and then ponder the likelihood of various rear-looking narratives. By mentally removing the self from the present, it allows us to focus on possibilities rather than myopically focusing on today’s cross-currents. For instance, maybe the narrative at the end of 2023 will be that the market bottomed in the fall of 2022, as the Fed’s aggressive rate increases combined with China’s reopening to collectively slow runaway inflation much faster than anyone anticipated.

It is hard to overstate the importance of China’s reopening, as China is the second-largest economy in the world at approximately $15T in GDP, just behind the US at $21T; it is three times the size of Japan, the next-largest economy. While China’s reopening stimulates aggregate global demand, it also unclogs global supply chains, thereby easing pricing pressures around the world. Markets apparently began to discount this event starting at the beginning of November, as the Chinese market bottomed on October 31^st. It is likely not a coincidence that the US bond market’s expectation for domestic inflation over the coming year also hit a local peak of 3% at the end of October and proceeded to fall almost in half, hitting a low this month of 1.6%, a far cry from the rear-looking headline CPI number of 6.5% over the trailing 12 months, and well below the Federal Reserve’s own self-imposed “symmetrical” target of 2%. Meanwhile, the commodity spot index has found some support at the same level where it was when the market started to discount China’s reopening.

The notion that inflation is under control is not in keeping with the previous shareholder letter’s tone, which highlighted the possibility that the Fed was still behind the curve on rate hikes and that inflation had a reasonable chance of persisting. That note spawned in mid-October, prior to the market catching any whiff of China reopening.

Risks and potential rewards are always changing in a multivariate universe. At the time of this note, we interpret bond markets as telling us that the biggest risk to markets and the economy is a Fed that will continue its familiar pattern of staying the course too long, and pointing to a scenario in which the final rate hike comes early this summer, followed by aggressive rate cuts, which, if accurate, would mean eventually ending the year with a discount rate at about the same level it is today. Still, unanticipated changes in the environment are likely between this letter and the next as well; one that we think the market may underappreciate is that today’s monetary system is better understood every year, so central bankers are likely well aware of the inverted yield curve and what it means. The economy may be slowing, and if the Fed hikes one too many times, we know that firing up the printing presses can likely solve a garden-variety recession, which may be what Bitcoin is sniffing out.

The world and data may change around us, but our approach remains consistent – looking for mispriced equities and bonds that are likely to do well over the next few years; there is no shortage of compelling valuations out there today, especially in securities that have sold off heavily and appear to already be pricing in a weaker economic environment. We are on the prowl, and as always, we remain the largest investors in the strategy and appreciate all comments and questions.

Bill Miller IV, CFA, CMT

Strategy Highlights by Jack Metzger, CFA

Strategy Highlights

In the fourth quarter, the Income Strategy rose 11.68% (net of fees), outperforming the ICE BofA Merrill Lynch High Yield Master II Index’s 3.98% gain and outperforming the S&P 500’s 7.56% gain. (Exhibit 1). The strategy ended the quarter down -23.61% year-to-date (YTD), or 1,240 basis points behind the high yield index and 550 basis points behind the S&P 500.

Exhibit 1: Performance of Income Strategy Versus High Yield, Equity Indices, Through 12/31/2022¹

Time Period	Income Strategy (net)	ML HY II	S&P 500
QTD	11.68%	3.98%	7.56%
1-Year	-23.61%	-11.22%	-18.11%
5-Year	1.55%	2.12%	9.42%
10-Year	4.73%	3.94%	12.56%
YTD	-23.61%	-11.22%	-18.11%
Inception (annualized since 4/2/2009)	10.22%	8.50%	14.35%

Source: Bloomberg, Miller Value Partners

Top Contributors

The Buckle, Inc (BKE) was the top contributor for the quarter. The company reported 3Q23 net sales of $332.3MM, +4.0% year-over-year (Y/Y), ahead of consensus of $326.7MM, and earnings per share (EPS) of $1.24, -1.6% Y/Y, ahead of analyst expectations for EPS of $1.19. Comparable store sales and online sales increased 3.0% and 8.8% Y/Y, respectively, during the quarter. Inventory rose +49.2% Y/Y and +18.6% sequentially to $152.3MM, as of quarter-end, while gross margin expanded +163bps sequentially to 49.8%. The company also reported that December net sales grew 7.9% Y/Y, bringing fiscal year-to-date (YTD) net sales as of 12/31/22 to $1.28B, or +3.7% Y/Y.
HeidelbergCement AG (HEI GY) rose this quarter after it reported 3Q22 revenue of €5.85B, +15.7% Y/Y, ahead of consensus of €5.57B, and operating earnings before interest, taxes, depreciation, and amortization (EBITDA) of €1.19B, +1.5% Y/Y, in-line with analyst expectations. High energy and raw material costs negatively impacted results in the quarter, as cement and clinker sales volumes fell -8.0% Y/Y to 31.1 million tons (Mt) and aggregates sales volumes fell -5.0% Y/Y to 82.0 Mt. However, the prices of domestic cement and aggregates rose 27.4% and 20.1% Y/Y, respectively, which helped partially offset demand headwinds to support an EBITDA margin of 20.4% in the quarter, -325bps Y/Y. For FY22, management is guiding for “strong revenue growth” and operating EBITDA of €3.73B, at the midpoint.
Viatris Inc (VTRS) gained after reporting 3Q22 net sales of $4.07B, -10.0% Y/Y (-1% operationally), below consensus of $4.14B, and Adjusted EBITDA of $1.50B (36.8% margin), ahead of consensus of $1.44B. Free cash flow (FCF) for the quarter came in at $765.1MM, which brings trailing twelve-month (TTM) FCF to $2.88B, or a FCF yield of 22.9%. Viatris paid down ~$614MM of debt in the quarter, bringing YTD debt reduction to ~$2.1B, in-line with the company’s previously stated target of reducing debt by ~$6.5B between 2021-2023. Additionally, the company announced the acquisitions of two Ophthalmology (eyecare) companies, Oyster Point Pharma and Famy Life Sciences, for an aggregate purchase price of ~$700-750MM, with management expecting these transactions to add at least $1B in sales and $500MM in Adjusted EBITDA to Viatris by 2028.

Top Detractors

Carvana Co 10.25% 5/1/2030 was the top detractor for the quarter. The auto retailer reported 3Q22 revenue of $3.39B, -2.7% Y/Y, below consensus of $3.71B, and gross profit per unit (GPU) of $3.5K, +4.2% sequentially, but -25.1% Y/Y, and below consensus of $3.74K. Adjusted EBITDA for the quarter came in at -$186MM, compared to 3Q21 EBITDA of $20MM, as the company sold 102.6K retail units in the quarter, -8.4% Y/Y. Management noted it has made strong progress in reducing selling, general, and administrative (SG&A) expenses on an absolute dollar basis, as the company is still striving to eventually achieve total GPU in excess of $4K and significant adjusted EBITDA profitability at current volume levels, although the timeline for achieving these goals is uncertain. During the quarter, multiple creditors, including Apollo and PIMCO, which account for ~70% of Carvana’s total outstanding unsecured debt, agreed to a cooperation agreement in the event of any debt restructuring negotiations with the company.
Greenidge Holdings 8.5% 10/31/26 fell as the strategy ultimately exited its position in the Bitcoin miner during the quarter. Greenidge reported 3Q22 revenue of $29.4MM, -17.9% Y/Y, and an Adjusted EBITDA loss of -$2.3MM, compared to 3Q21 EBITDA of $21.2MM. The company produced 866 bitcoin in the quarter, +18.8% Y/Y, while achieving a mining capacity hash rate of 2.4 exahash per second (EH/s), compared to a 3Q21 hash rate capacity of 1.2 EH/s. The price of Bitcoin fell another -14.9% in the quarter to $16.5K as of 12/31/22, which has generated further uncertainty regarding the miner’s ability to continue as a going concern, with management noting in the 3Q22 earnings release that it will continue to discuss potential asset sales to further enhance its liquidity position, which stood at ~$39MM as of 9/30/22.
B Riley Financial (RILY) slumped in the quarter after reporting 3Q22 operating revenue of $328.2MM, -9.7% Y/Y but +23.1% sequentially, and Adjusted EPS of $2.64, +25.7% Y/Y. Operating Adjusted EBITDA for the quarter came in at $106.2MM, or a margin of 32.4%, +455 bps Y/Y. Management maintained a quarterly dividend of $1/share, implying an annualized yield of 12.5%, and authorized $50MM worth of share repurchases, or ~5.5% of the company’s market cap. The company provided guidance for 4Q22 Operating Adjusted EBITDA of $95MM, -10.5% sequentially at the midpoint. Additionally, management reported potential 4Q22 exposure to investments related to digital asset mining and crypto services businesses of ~$39MM, “of which $26MM represents a loan to a borrower that has since filed for bankruptcy”, which helped relieve investors’ concerns about the company’s exposure to Core Scientific, the Bitcoin miner which filed for bankruptcy in the quarter.

Portfolio holdings may change at any time

¹The performance figures reflect the results of the Income Strategy Composite net of management fees and certain other expenses. For important additional information about Income Strategy performance, please click on the Income Strategy Composite Performance Disclosure. Past performance is no guarantee of future results.

Past performance is no guarantee of future results. For important additional information on Income Strategy performance, please click on the Income Strategy GIPS Composite Disclosure. This additional information applies to such performance for all time periods.

Investment Risks: All investments are subject to risk, including possible loss of principal.

The views expressed in this report reflect those of Miller Value Partners portfolio manager(s) as of the date of the report. Any views are subject to change at any time based on market or other conditions, and Miller Value Partners disclaims any responsibility to update such views. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. Past performance is no guarantee of future results.