Letter to investors 1H2025

Theme and Background

This chapter is from Azvalor's first-half 2025 letter to investors, discussing the current extremely polarized market environment: growth stock valuation bubbles coexist with forgotten value stocks. The report argues that the market is approaching a state similar to that before 2022 — the "cicadas" (high-valuation tech stocks/indices) are thriving, while the "ants" (neglected value sectors) are hoarding cheap assets for winter.

Core Views

• The current total market cap of US stocks as a percentage of GDP (210%) has hit a record high since 1970, with market sentiment extremely optimistic, similar to the eve of the 2000 and 2007 bubbles. Historical patterns show that after such peaks, markets often experience declines of over 50%.
• Significant investment opportunities exist in largely overlooked sectors such as coal, oil, emerging markets, and UK small caps — their valuations are at historic lows, while fundamentals (consumption growth, resource scarcity) have not collapsed as the market expects.
• Azvalor believes that the market's "cicadas" (indices/growth stocks) will again be exposed in winter, while the "ants" (value portfolios) will deliver excess returns like they did in 2022 (when the S&P 500 fell over 20%, Azvalor's portfolio rose 45%).

Key Arguments and Data

Extreme Valuation Divergence: Growth vs Value

Indicator	Value	Comparison
MSCI ACWI Large Cap Growth PE	32x	Double that of small-cap value
MSCI ACWI Small Cap Value PE	13.9x	Less than half that of growth
Market cap of the Magnificent Seven	$18.6 trillion	Exceeds the combined stock markets of China, UK, and Brazil
Meme cryptocurrency market cap	~$80 billion	-

Global Stock Market Valuation Risk

Indicator	Current	Historical Peak and Subsequent Decline
Global stock market cap/GDP	117%	2007: 100% (fell over 50%), 2000: 110% (fell over 50%), 1929: 65% (fell over 50%)
US stock market cap/GDP	210%	Highest since 1970

Real Fundamentals of Forgotten Sectors

• Coal: Still accounts for nearly 30% of global primary energy demand, consumption has grown at 1.2% annually over the past decade, hitting a record high in 2024; Asian consumption grows 2% per year, representing nearly 50% of the region's primary energy. Yet Western coal companies are valued as if they are about to disappear.
• Oil: Western companies' reserves are less than 10 years of production, and the energy sector's weight in stock indices is only 3% (a historic low), far below the 14% in 2008 and the 30-year average of 7.5%. Actual oil consumption has seen absolute growth over the past two years exceeding that of renewables (doubled if natural gas is included). Per capita consumption in emerging markets remains far below developed countries: India ~1 barrel/person/year, China 4, Europe/US 15-22; oil accounts for 34% of global primary energy (59% when including natural gas).
• Emerging Markets (Brazil as an example): The Brazilian currency has depreciated 75% since 2011; the stock index valuation is below COVID-19 levels. The author draws a parallel to past investment experience in Argentina — buying Central Puerto, Loma Negra, and Transportadora de Gas del Sur at lows in 2021, with average returns of 150%.
• UK Small Caps: The FTSE SmallCap index remains below its level five years ago, valuations are below historical averages, and the discount to US stocks is at a record.

Companies/Assets Mentioned

Company/Asset	Role	Key Data	View
Magnificent Seven US tech giants (not named individually)	Representatives of market "cicadas"	Market cap $18.6 trillion, exceeds total of China, UK, Brazil	Overvalued, risks accumulating
Coal companies (not named)	Forgotten "ants"	Coal accounts for 30% of global primary energy, consumption continues to grow	Bullish, undervalued
Western oil companies (not named)	Sector abandoned by the market	Reserves <10 years of production, index weight 3%	Bullish, actual oil demand is resilient
Central Puerto	Argentina investment case (bought at lows in 2021)	Average return 150%	Successful case, hints at similar opportunities in Brazil
Loma Negra	Same as above	Average return 150%	Successful case
Transportadora de Gas del Sur	Same as above	Average return 150%	Successful case
FTSE SmallCap index constituents (not individually named)	UK small-cap value stocks	Index below its level five years ago, valuation discount at record	Bullish, but require careful management selection

Investment Implications

• Directional advice: Investors should significantly reduce exposure to high-valuation large-cap growth stocks and reallocate to market-abandoned value sectors, particularly coal, oil, emerging markets (Brazil as a representative), and UK small caps. These sectors' valuations are at historically extreme lows, while fundamental demand has not disappeared (oil and coal consumption are still growing, and emerging market penetration potential is vast).
• Execution points: Do not simply buy forgotten sectors passively through ETFs. One must screen deeply, investing only in robust companies with unique market positions, management integrity, and alignment with shareholder interests. Azvalor's "ant method" requires contrarian buying and enduring short-term solitude, waiting for the market turn.
• Risk warning: If the market continues to favor growth stocks in the short term, value portfolios may continue to underperform; but history shows that extreme valuation divergences eventually revert, as the 2022 reversal case demonstrated.

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Theme and Background

This chapter is the concluding section of Azvalor’s first-half 2025 report, summarizing the semi-annual performance, portfolio adjustments, and valuation status of its three flagship funds: Azvalor Internacional, Azvalor International Sicav Luxembourg, and Azvalor Managers. The report emphasizes that despite the overall market downturn, portfolio valuation attractiveness has reached historically rare levels.

Core Views

The author judges that the current portfolio’s potential upside exceeds 100%, implying double-digit annualized returns over the next several years. The counterintuitive aspect is that many global and regional leading companies are mispriced due to short-term pessimism, yet they possess irreproducible assets or cost advantages, and most have strong balance sheets.

Key Arguments and Data

• Azvalor Internacional FI: Net asset value fell 1.7% in the first half (to EUR 231.1 million), with cumulative return of +131%; the current portfolio’s intrinsic value is approximately 2.08 times its net asset value (potential upside +108%).
• Azvalor International SICAV Lux: Average free cash flow yield of 13%, weighted average ROCE of 21%, potential upside +105%.
• Azvalor Managers: Flat return in the first half, cumulative return of +71% over more than six years since inception; approximately 30% of holdings exposed to emerging markets (including China), 73% in small- and mid-cap stocks, with a P/E of 10x, at a roughly 50% discount to global equities. Received nearly 30 takeover offers over the past five years, including six in 2024 and several in the first half of 2025.
• Portfolio adjustments: Added Schlumberger and Sprott Physical Uranium Trust; reduced positions in Tenaris and Catalana Occ; Barrick Mining was the best contributor in the first half.

Fund	1H 2025 Return	Cumulative Return (as of 6/30)	Potential Upside	Key Valuation Metrics
Azvalor Internacional	-1.7%	+131%	+108%	Specific PE/FCF not disclosed
Azvalor International SICAV Lux	Not separately listed	Not listed	+105%	FCF yield 13%, ROCE 21%
Azvalor Managers	Flat	+71% (6+ years)	Not disclosed	P/E 10x (vs 50% discount to global)

Companies/Assets Involved

• Schlumberger (new long position)
• Sprott Physical Uranium Trust (new long position)
• Tenaris (reduced)
• Catalana Occ (reduced)
• Barrick Mining (best performer in 1H, long position)
• Japanese specialist manager (new allocation of approximately 4% of portfolio)
• Chinese specialist manager (one added each in early 2024 and early 2025, together forming the emerging market allocation)

Investment Takeaways

Azvalor continues to execute a deep value strategy, focusing on companies overlooked by the market that possess irreproducible assets, low-cost advantages, or industry leadership. The current portfolio’s valuation discount (FCF yield 13%, P/E 10x) and potential upside (>100%) imply that, if historical patterns hold, double-digit annualized returns are likely over the next several years. Investors can pay attention to similar characteristics—high free cash flow yields, high ROCE, low debt, and small- to mid-cap and emerging market companies that frequently attract takeover offers. The new holdings (uranium, oilfield services) signal exposure to the energy and raw materials sectors.