Knighthead Capital Management’s Stock Holdings

Updated on December 18th, 2020 by Nikos Sismanis

Knighthead Capital Management is a long-short hedge fund that specializes in the following investment types:

The company was founded in 2008 by Ara Cohen and Thomas Wagner.  Since that time, Knighthead Capital Management has grown to have discretionary management over $5.6 billion in assets.

Investors following the company’s 13F filings over the last 3 years (from mid-November 2017 through mid-November 2020) would have generated annualized total returns of -11.8%.  For comparison, the S&P 500 ETF (SPY) generated annualized total returns of 12.2% over the same time period.

Note:  13F filing performance is different than fund performance.  See how we calculate 13F filing performance here.

You can download an Excel spreadsheet with metrics that matter of Knighthead Capital Management’s current 13F equity holdings below:

Keep reading this article to learn more about Knighthead Capital Management.

Table Of Contents

The Knighthead Family of Companies

Knighthead Capital Management invests the ‘float’ from its related company, Knighthead Annuity & Life Assurance Company.  This company is based in the Cayman Islands and has more than $2 billion in assets.

Knighthead also advises for Jazz Re, a captive reinsurance company owned by Sentinel Security Life Insurance Company with the purpose of reinsuring select blocks of life insurance policies.  Sentinel Security merged with Advantage Capital Holdings in 2016.

In addition, Knighthead advises for Equitable Life & Casualty Insurance Company, a life and casualty insurance company.  Further, Knighthead advises for Trinity Life Insurance Company.

Knighthead Capital Management is also related to real estate loan originator Knighthead Funding.

Knighthead’s Holdings

Knighthead’s public-equity portfolio is very concentrated, holdings just 10 stocks in 4 different industries. Its largest holding is PG&E, accounting for around 2/3 of the portfolio.

Source: Company Filings, Author

1.PG&E

Knighthead Capital Management has bet heavily on California electric and gas utility PG&E (PCG).  This investment certainly falls under the ‘special situations’ banner.

PG&E was responsible for several California wild fires from 2015 through 2018.  The company was levied with a massive $15 billion fine.  As a result, the company filed for Chapter 11 bankruptcy reorganization in January of 2019.

Knighthead, together with Abrams Capital Management and Redwood Capital Managementproposed a restructuring plan for PG&E in a detailed letter.

Knighthead’s PG&E investment has yet to pay off.  The company sizably increased its PG&E position in the first quarter of 2019, from 1,250,000 shares to 10,432,022 shares.  And Knighthead’s position has only increased.  The company’s latest 13F filing shows it now holds 25,210,936 shares, worth nearly $290 million at current prices.

It’s impossible to know exactly when Knighthead purchased the bulk of its shares, but the average share price in Q1 2019 – when Knighthead loaded up on shares – was $16.34.  In its recent filing, for Q3 2020, Knighthead’s stake decreased  by  35%  indicating that the fund has likely lost a chunk of its patience for a potential recovery, preferring to allocate a part of this capital elsewhere. Still, the stock makes for 66.7% of Knighthead’s public-equity holdings, which means that the fund’s high-conviction thesis remains alive.

This lopsided risk-reward ratio is not something that happens often.  If PG&E ends up failing – and that’s something Knighthead has at least some control to prevent – then Knighthead will have a complete loss on its position.  That’s the worst case scenario.  But the upside is that PG&E could end up surviving, resulting in multi-bagger returns for Knighthead.  This ‘heads I gain $3, tails I lose $1’ style of investing is likely to generate solid returns over a diversified portfolio.

This level of concentration is likely due to the influence that Knighthead has on the situation.  Having some level of control warrants a more highly concentrated position, all other things being equal.

It’s important to note that Knighthead does not invest only in equities.  The firm is far more diversified than the outsized equity position in PG&E would seem to show at first glance.  Indeed, their 13F filing shows put and call options as well.  Additionally, the firm invests heavily in debt/credit markets.  Overall, the PG&E position is worth around $290 million right now.  That’s only ~3.7% of the firm’s assets under management.

2. Marathon Petroleum (MPC)

Another one of Knighthead’s heavy bets on distressed equities is its recent, new position in Marathon Petroleum (MPC). Knighthead initiated a position during Q2, acquiring 1,450,555 shares, currently worth around $59 million. Marathon Petroleum was a Marathon Oil Corporation (MRO) spinoff, which occurred in 2011 to unlock further shareholder value.

Marathon Oil is currently trading near all-time lows, as COVID-19 adversely impacted its oil exploration and production activities, forcing management to suspend the dividend completely. In contrast, while Marathon Petroleum’s operations were also negatively impacted, its petroleum refining, marketing, retailing, and transportation have performed better during the pandemic. In fact, during Q2 2020, the company broke even and during Q3 posted relatively manageable losses, which is quite encouraging.

As a result of undergoing a more manageable situation than its former parent company, Marathon Petroleum has retained its quarterly dividend, which currently yields around 5.41%. As a result, while shares have significantly declined over the past year, they still trade near their 2016’s lows.

Further, during August, the company had announced closing the sale of its Speedway convenience store and gas station chain to Seven & I Holdings’ (OTC:SVNDF) 7-Eleven subsidiary for $21B in cash. The divestment should significantly boost MPC’s liquidity, which should helped with retaining its dividend as well as staying solvent while demand for its refining and transportation operations gradually picks up again over time.

Due to a better than expected performance so fat coming out of the pandemic, Marathon Petroleum’s shares have rallied fairly notably, currently at $41.4, which means that the company has recovered its early losses, is now holdings shares with unrealized gains. Knighthead average purchasing price is around $37, and the fund didn’t  make any changes to its stake during the quarter.

3. Sabre Corporation

Knighthead’s recent investment in Sabre Corporation can further display its continuous capital allocation towards equities facing significant pressure. Every bit of the company’s operations is directly related to the travel and tourism industry, resulting in a massive disruption of its operations during the pandemic.  With its revenues split amongst its travel marketplace, airline, and hospitality solutions, Sabre’s quarterly sales dropped from around $1B, under normal conditions, to just $83 million during Q2 2020, a massive, 92% plunge.

During Q3, the company showed signs of recovery, posting revenues of $278 million. Despite the increased sales, however, these levels are nowhere near its pre-COVID ones. Due to lack of economies of scale, the company is not able to yet produce profits, hence posting a quarterly loss of $310 million.

Knighthead has structured its bullish position in Sabre through both acquiring shares, and buying calls. The fund acquired 500,000 shares during Q2, worth around $3.46 million. The bigger bet, however, comes from Knighthead’s ~ $16 million worth of call options.  During its most recent filing, for Q3, the company increased its position by a massive 640%, as Sabre’s sales recovery likely exceeded management’s expectations. The rest of the market seems to agree with Knighthead, as shares have rallied back to $10.90, indicating returns of around 62% based on the fund’s average purchase price of around $67.72.

While Sabre’s sales may take a while before completely recovering, Knighthead could end up massively benefiting, amid normalization. The company would generate more than $330 million in net profits under a normal financial year. At its current valuation of just $3.4 billion, the stock is trading around 11.3 times its under-normal-conditions profitability. The market is forward-looking, potentially expecting that a recovery to such high net income levels may take a long time, if it even materializes in the first place.

As a result, while Knighthead’s equity and option positions could pay big bucks amid a rebound, management’s capital allocation in Sabre could also end up being a significantly risky move. If shares fail to advance before the contracts’ expiration date, the fund could face considerable losses.

4. JP Morgan Chase & Co.

JP Morgan is Knighthead’s only position in the financial sector, which the fund initiated during Q2 by buying just over $15 million worth of call options, instead of ordinary shares. The fund’s investing decision to purchase bullish options likely comes from the fact that while the overall market has rallied over the past few months, led primarily by tech, many sectors, including financials, have lagged. JP Morgan’s latest quarterly results remained robust, achieving a considerable $9.44 billion worth of net income, during Q3. With shares trading at a P/E of just 15.64, Knighthead’s reasonable expectation is that the wholesale banking giant will rebound towards a more appropriate multiple, hence the call contracts.

The company’s 3.04% yield and considerable buyback volume, should further assist investors in gradually becoming more attracted to JPM, versus the currently quite overvalued equities in the tech sector. For context, Jamie Dimon’s company has repurchased around 25% of its total shares outstanding over the past decade, showcasing a strong commitment towards return capital to shareholders.

5. Mercer International Inc.

Like JP Morgan being Knighthead’s only exposure towards financials, Mercer is its only exposure towards basic materials. The Canadian company specializes in manufacturing and selling northern bleached softwood kraft (NBSK), which is the paper industry’s benchmark grade of pulp. Due to the niche and small market it is operating in, Mercer has a market cap of just $365, which makes for quite a tiny company in the context of the public markets. The trust’s position is quite unique, in that it is its oldest holdings, with its first position dating back to Q4 of 2010. Knighthead has regularly traded its shares, as its cyclical demand for its products allows for regular stock swings.

As the pandemic reduced the demand for Mercer’s industrial-applied products, Knighthead’s position has almost halved vs. the prior year. Considering that Knighthead has been trading the stock for nearly a decade, we believe that Mercer does not indicate a long-term position. Instead, it is a vehicle used for opportunistic trades, based on the market’s cyclicality. The company’s initiation of a dividend, over the past few years, however, should provide Knighthead with that extra dividend income while it holds its shares.

The stock is currently yielding around 2.57%, due to the recent dividend cut. Still, Sabre remains confident in the stock, which makes for around 2% of Knighthead’s public-equities portfolio.

6. Energy Transfer

Knighthead’s position in Energy transfer remained unchanged during Q3, after it was significantly trimmed during Q2, when management had dumped around 81% of its shares. The company is currently left holding only around $1 million of them. The position is currently worth around $5.8 million and accounts for around 1.3% of its equities portfolio. Knighthead also holds around $4.6 million worth of calls, expanding its investment strategy.

Energy transfer makes for quite a controversial investment case. On the one hand, the company had continuously increased or held the dividend constant since its IPO back in 2005. Even during the Great Financial Crisis, which significantly affected its natural gas transportation pipelines, the company kept on delivering robust distributions to its unitholders.

On the other hand, Energy Transfer just recently cut their dividend, due to the slump in demand for energy transportation services. Despite the cut, shares are currently yielding a fat 15.23%. While Knighthead has definitely suffered in this position, losing money on its ET stake, shares may offer a compelling investment case for current investors who wish to gain exposure in the sector.

Not only is the company’s yield massive and covered by operating cash flows, but the company is also often appraised as owning some of the highest-quality assets of pipelines extending towards Texas, New Mexico, West Virginia, Pennsylvania, Ohio, Oklahoma, Kansas, and Louisiana. Its storage operations have also greatly contributed over the past couple of quarters, as oil producers were forced to store their merchandise due to the depressed commodity prices over this period- Hence its dividend coverage.

Knighthead’s investment strategy of holding both shares and calls indicates that the fund expects a much faster recovery on ET’s shares, potentially attempting to capitalize on a huge rebound. Moreover, buying calls versus only buying the stock lets you control the same amount of shares with less money, which should allow management to free up capital to allocate elsewhere, as well.

7. Genesis Energy

Like many of the midstream companies that were forced to cut their distributions, one such case is the Knighthead’s next holding, Genesis Energy. The fund initiated a position by purchasing 266,378 worth just under $2 million during Q2 when the stock was trading at around $6-$7. The company’s operations were adversely impacted during the first half of 2020, as domestic and international customers of sodium hydrosulfide and caustic soda were constantly canceling orders during the peak months of the pandemic. As a result, management was forced to cut its quarterly distributions by 72%, to $0.15.

It’s also worth noting that Genesis had cut its distributions again in 2017. Shares are currently trading at the same levels as Genesis’ purchasing ones, while the fund collects a fat 8.45% as it waits for a potential appreciation.  The fund even increased its position by 98% during its latest filing, in Q3, doubling down on the stock, likely encouraged by the coverage of its current dividend levels.

Despite Knighthead’s enthusiasm, we see Genesis’s operations quite riskier than the rest of the midstream sector, as commodities such as sodium hydrosulfide and caustic soda are more cyclical than oil and natural gas, offering less predictable cash flows. With shares near a 23-year low, we believe that Knighthead’s new position was mostly executed in hopes of a quick trade amid a potential swing and not as a long-term investment position.

8. Equitrans Midstream Corp & Contura Energy

Equitrans & Contura are two midstream companies that collectively occupy around 1.6% of Knighthead’s total holdings. The position in Equitrans is relatively new, initiated in Q2 for around $8.5 million. During Q3 the fund increased its stake in the company by 33%, expanding its current stake at around $7.1 million. The fund’s tiny stake in Contura is worth just $85.500, and was held constant.

Both companies have had a rough past couple of months, undergoing dividend cuts and steep share losses. Considering that the company’s stake in Contura is incredibly small, we saw little justification, other than what may be a small bet towards a moonshot scenario. This may be just becoming a reality, however, as shares have jumped 5-fold since March.

However, when it comes to Equitrans, Knighthead’s conviction pick may eventually end up being, more predictable long-term hold. Despite facing challenges lately, like the rest of the companies in the sector, its management recently lifted its FY2020 adjusted EBITDA outlook to $1.20B-$1.22B from $920M previously, after reporting Q3 adjusted EBITDA of $282.2M. Further, while other companies faced a significant revenue decline (e.g., Genesis Energy experienced a ~-40% during Q2), in Equitrans’ case, that figure was “only” 16%, due to strong storage sales.

9. Enterprise Products Partners L.P.

Replacing HCA Healthcare as its 10th and final holding, Knighthead initiated an entirely new position in Enterprise products Partners, further betting on a rapid recovery in the midstream space. The fund bought its stake at an average price of around $15.7, which has already been a successful pick now that shares trade around $21.50.

Despite its Q3 revenues falling by 13% to $6.92B, missing estimates, distributable cash flow (DCG) remained steady at around $1.65B, translating to a 1.7x coverage of the $0.445/unit cash distribution and retention of $669M of DCF. With such improved financials, the possibility that the company will not resort to cutting the dividend have significantly increased. EPD is one of the few companies in the sector to have maintained their distributions, which is a testament to their high-quality family of assets.

Final Thoughts

The firm generally looks to invest where other capital is scarce – potentially leading to higher returns. This is evident in the company’s distressed credit investing and, in particular, the PG&E example listed above, as well as its recent picks in Marathon Petroleum, Genesis Energy, and Equitrans.

You can download an Excel spreadsheet with metrics that matter of Knighthead Capital Management’s current 13F equity holdings below: