Children's Investment Fund on Porsche & Japan Tobacco: Q3 Letter Excerpt ~ market folly

Wednesday, November 7, 2012

Children's Investment Fund on Porsche & Japan Tobacco: Q3 Letter Excerpt

Christopher Cooper-Hohn's Children's Investment Fund was up 1.6% for the third quarter and up 18.26% year to date as of the end of Q3.  TCI runs a concentrated portfolio and their Q3 letter to investors provides updates on their positions in Porsche SE as well as Japan Tobacco, which we've excerpted below:

Porsche SE

Back in July, Volkswagen (VW) announced they would purchase the other 50% of Porsche that they didn't own yet for 4.5 billion euros.  The deal's closure makes Porsche essentially a holding company that has 2.5 billion euros in cash and 50% of the common stock of VW.

As to their thesis, TCI writes:

"Porsche currently trades at a large discount to NAV due to uncertainty regarding the outcome of several legal cases that have been brought against the company in Germany and the US, regarding alleged market manipulation in its failed attempt to take over VW in 2008. Porsche holds the view that these allegations are unfounded and without merit, and during the quarter it won a significant victory when a German court dismissed two of the cases. While the amount of damages being sought in these cases was small, at under €5 million, we think they should provide a precedent for the much larger claims of €4 billion that are still pending at the same court. Our view is that the amount Porsche will eventually pay to settle these cases will be much less than the market is currently pricing in. And once the litigation is settled, there is a good chance that VW and Porsche will merge and the discount to NAV will close completely."

Children's essentially believes they can make money in four ways:

1. "Strong underlying performance from the investment in VW"
2. "A successful and benign resolution to the legal cases"
3. "Large and increasing dividends from VW flowing to Porsche shareholders"
4. "Long-term potential for a merger between Porsche & VW"

Japan Tobacco

Children's points to Japan Tobacco's strong recent earnings and notes that VAT in Japan is rising which should allow for price increases. 

The company is also changing the name of its largest selling brand from 'Mild Seven' to 'Mevius'.  While such a move might seem odd at first glance, the company is doing so because this will allow them to sell the product in other countries where the use of the word 'mild' in product names is essentially prohibited. 

Here's why TCI sees Japan Tobacco as compelling:

"Dividend guidance is ¥12,000 per share which implies a payout ratio of approximately 36%. JT is expected to return an estimated ¥370bn to shareholders this year of which ¥250bn is through a share buyback exceeding their estimated profits. This should be a strong catalyst for the stock to re-rate in line with its global peers. Valuations are very attractive post the recent sell-off, JT trades on 10.5x P/E for the year ending March 2014 at a 30% discount to the average of BAT and PMI. We expect the stock to re-rate post the share placement by the Japanese government toward parity with BAT and PMI."

Children's Top 10 Positions (as of Q3 end)

1. Lloyds Bank Bonds: 20.1% of NAV
2. News Corp: 18.8%
3. Japan Tobacco: 16.8%
4. Porsche SE: 15.5%
5. QR National: 13.3%
6. CESP: 12.8%
7. Red Electrica: 10.9%
8. Coal India: 9.4%
9. Safran: 8.7%
10. Enagas: 8.0%

For more on this fund, we've previously posted Children's thesis on News Corp, Union Pacific & Walt Disney.

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