Knighthead Capital Management’s Stock Holdings

Updated on September 21st, 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-August 2017 through mid-August 2020) would have generated annualized total returns of -21.2%.  For comparison, the S&P 500 ETF (SPY) generated annualized total returns of 11.9% 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

1. PG&E (PCG)

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 Management, proposed 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 22,296,856 shares, worth nearly $200 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 Q2 2020, Knighthead’s stake increased by 49%  indicating that the fund doubled down on the stock at around $8.60 to $9.50. Shares are currently trading at around $9.71.

With that said, shares did briefly bottom at under $7 per share, so depending on when Knighthead made its large purchases, the company could potentially be up on this investment.

The real payoff of investing in PG&E is hopes of a restructuring deal that is beneficial for shareholders.  Shares were trading at ~$70 at their peak in mid 2017, so the upside return is measured in multiples.

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 it’s position.  That’s the worst case scenario.  But the upside is that PG&E could rise significantly, resulting in a 2x to 5x or more gain.  This ‘heads I gain $3, tails I lose $1’ style of investing is likely to generate solid returns over a diversified portfolio.

Interestingly, Knighthead’s equity portfolio is not highly diversified.  Knighthead has over 65% of their equity portfolio in PG&E.  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 $200 million right now.  That’s only ~3.5% 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. Knighthead initiated a position during Q2, acquiring 1,450,555 shares, currently worth around $46.8 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, 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 7.2%.

As a result, while shares have significantly declined over the past year, they still trade near their 2016’s lows. Still, the company managed not to lose additional money in Q2, despite oil demand remaining low due to travel restrictions still holding strong across the globe. This should showcase both management’s robust execution skills and a resumption towards more substantial levels of profitably, as normality returns across global markets.

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

3. Sabre Corporation (SABR)

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 among 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 92% plunge. As a result of lacking sales, underlying expenses still running, as well as incurring additional business model restructuring expenses, the company ended the quarter with a $444 million loss.

Shares were trading at around $22 before the pandemic, but have currently fallen to just below $7, similar to most of the tourism industry equities. 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.

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 $2.1 billion, the stock is trading around 6 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 off amid a rebound, management’s capital allocation in Sabre could also end up being a risky move. If shares fail to advance before the contracts’ expiration date, the fund could face considerable losses.

4. JP Morgan Chase & Co. (JPM)

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 $4.69 billion worth of net income, during Q2. With shares trading at a P/E of just 13, Knighthead’s reasonable expectation is that the wholesale banking giant will rebound towards a more appropriate multiple, hence the call contracts.

The company’s 3.7% 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. (MERC)

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 $481, 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, currently yielding around 3.6%. Sabre makes for just over 5% of Knighthead’s public-equities portfolio.

6. Energy Transfer LP (ET)

Knighthead’s position in Energy Transfer was significantly trimmed during Q2, as management dumped around 81% of its shares, currently left holding only around 217,334 of them. The position is currently worth around $1.3 million and accounts for around 2% of its equities portfolio. However, Knighthead went and purchased around $7 million worth of calls, switching its investment strategy.

Energy transfer makes for quite a controversial investment case. On the one hand, the company has 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, with many companies in the sector having cut their dividend, due to the slump in demand for energy transportation services, investors have been worried in terms of how long Energy Transfer can hold on to its current dividend, which yields a monstrous 20%.

However, where things become interesting is that ET’s current dividend remains covered by around 1.6 times the company’s distributable cash flows. This is the case even after H1 2020’s financials, which were considerably affected due to the pandemic.

Energy Transfer is 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 dumping shares in exchanged 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 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 (GEL)

As we mentioned, many of the midstream companies didn’t end up being as resilient as Energy Transfer and 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. Shares have declined further since breaching under the $5 mark, which means that Knighthead is most likely on the red on this one.

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.

Overall, 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 (ETRN) & Contura Energy (CTRA)

Equitrans & Contura are two midstream companies that collectively occupy around 2.5% of Knighthead’s total holdings. The position in Equitrans is entirely new, as of Q2, amounting to around $8.5 million, whiles the tiny stake worth just $30,000 in Contura, 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 see little justification, other than what may be a small bet towards a moonshot scenario in which its tiny $150 million market cap skyrockets in the long run.

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 $1.17B-$1.22B from $920M previously, after reporting Q2 adjusted EBITDA of $263.2M.

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.0% during Q2), in Equitrans’ case, that figure was “only” 16%, due to strong storage sales.

9. HCA Healthcare (HCA)

HCA Healthcare is Knighthead’s only investment in the healthcare sector, holding around 50,000 shares worth around $6.7 million. Knighthead’s management imitated the position in Q1, when the company’s shares were trading at as low as $78, in the midst of the pandemic. The position was held constant during Q2. In the meantime, the stock has rallied considerably, currently trading at around $132.

The company delivered on analyst expectations, posting net income growth of 36.8%, reaching $1,07B, while its EPS jumped by approximately 40.4% to $3.16, boosted by management’s opportunistic buybacks on its cheap Q1 stock levels.

Considering that HCA is one of America’s largest hospital operators, offering medical and surgical services, its business model is COVID-19-proof. Further, its diversified revenue stream, including 184 hospitals and 123 freestanding surgery centers, should keep on delivering adequate shareholder returns.

Shares make of around 2% of Knighthead’s portfolio, and considering the stock’s rally over the past few months, it must be one of Knighthead’s most successful picks, as of lately.

Final Thoughts

The firm 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: