The 2015 London Value Investor Conference recently concluded and below are notes from each speaker's presentation.
Notes From London Value Investor Conference 2015
Neil Woodford – Woodford Investment Management
Q&A Session. Neil
Woodford is one of the UK’s most respected and successful fund managers. After
26 years at Invesco Perpetual where he managed £30bn in 2013, he left to set up
his own fund management business. Woodford has a background in economics and
finds it natural to combine bottom up stock picking with top down analysis. He
focuses on the medium and long term. Trying to value a business without taking
into account the macro and competitive environment is like music without
instruments; it doesn’t work. He places emphasis on portfolio construction –
not just the cheapest stocks. Trying to be scientific about the future is an
inherently odd thing to do. Portfolio construction is not a science, more an
art and involves lots of judgement. Valuation should always involve a range of
intrinsic values and not an absolute number. He uses revenues, earnings and
cash flows to value a business and spends a lot of time getting close to
businesses including meetings with management.
Considering history and the past is important when making a valuation
but they are only part of the judgement because companies, management and
technology can change. He does not spend time worrying about what other
managers are doing.
On how to value early stage companies – he uses the same
tools and valuation methods and flexes them. It is possible to value
pre-revenue businesses. They project cash flows just as they would for
established companies.
On fund management - smaller scale boutique style fund
managers have advantages as smaller teams are often more effective than large. Fund
management lends itself to being a cottage industry. The industry generally
charges too much in fees. The thing that offends him most is charging high fees
for closet indexing. The industry needs to become more open and transparent.
On the £18m fine that Invesco received after Woodford had
left - he said the FCA report is pretty comprehensive and makes good reading. The
fine related to disclosure rather than the use of excess leverage. He has
learnt from the incident to keep his new fund’s model very simple. They will
only use derivatives for currency hedging and nothing else.
On how to deal with underperformance - all investors go
through difficult periods. He
underperformed in the tech bubble of the late 90s. It was a draining and
emotional experience. Woodford said you must trust your discipline in good
times and bad. You need investment anchors to stay consistent.
On what he saw that made him sell out of Tesco at the same
time that Warren Buffett was buying - he did not like the way Tesco were
deploying capital and he became less convinced about future returns. “They were
planting flags.” He thought that competition would increase in the sector but he
did not foresee the rise of the discounters, Aldi and Lidl. After a 30-minute conference
call with the new CEO, Philip Clarke, he thought the problems facing Tesco were
structural and not cyclical and sold all of the stock within a few weeks.
Jonathan Ruffer – Ruffer LLP
“Value investor,” like “democrat,” is one of those words that
it is hard to say you are not. Ruffer thinks of himself as value investor but
in the negative sense that he is not a momentum investor. Unlike some value investors, Ruffer believes
we must grapple with and try to predict the future. The Romans distinguished
between futurum and adventus. Futurum refers to events that roll away from us.
For example, a turnip farmer was reasonably sure that he was going to eat
boiled turnip for dinner but the further ahead one looks the harder it becomes
to predict the future. Adventus refers to those events or shocks that come at
us and hit us, things that we could not possibly have seen coming. The momentum
investor concentrates on the futurum. Unlike
the Roman view of adventus (which sees the challenges that come at us as acts
of god) it is the task of the value investor to spot the next crisis coming. This
can be done by studying history, starting from the beginning of limited
liability in 1840. Stock market crashes do not come out of a blue sky. The big
question for investors now is how the huge amount of debt in the world will be
resolved? Collateral is a crucial part of the lending process but today central
banks have made too many gifts through QE and taken collateral out of
circulation. Since 2009, the money supply in the US, Europe and Japan has been
expanded. By keeping interest rates below the rate of inflation a new asset
bubble has been created. There is a crisis on the way in which all asset classes
will fall in value but it is hard to say exactly when. When the crisis does
arrive “safe” investments will be the most dangerous. As in Britain in the
1970s, inflation of 10-20% is likely.
Tim Hartch – Brown Brothers Harriman
Looks for companies with: a loyal customer base, a
sustainable competitive advantage, essential products and services, leaders in
attractive markets, strong balance sheets, high returns on capital, disciplined
capital allocation. Looks to own 25-35 stocks and invests with a 3-5 year
horizon. He sells investments when they approach intrinsic value. How is
intrinsic value calculated? Hartch takes into account revenue growth, margins,
business mix, capital intensity, ROIC, acquisitions, discount rate and terminal
value. He is looking for a 15% return per annum over five years.
Hartch warned that valuations generally are high due to QE.
Another bubble is forming in bonds, biotech, pureplay cloud applications, peer
to peer lending and M&A activity. It will be important to have cash on hand
to redeploy. There are still some good investments to be found.
Investment idea - Oracle (NYSE: ORCL)
Hartch’s funds made two new investments in 2014 and none so
far in 2015. They purchased Oracle stock in late in 2014 in the high $30s and
low $40s.
- High customer retention rate
- No.1 in application server, database, data warehouse,
engineered systems, identity and access management, middleware, UNIX server
shipments
- Recurring revenues, $20bn annual recurring license fees.
- Margins around 40%
- $14bn free cash flow in 2014
- Intrinsic value $50-60 per share
Investment idea – Campari (BIT: CPR)
- Brands include: Campari, Cinzano, Aperol, Skyy Vodka, Wild
Turkey. Hartch likes premium spirits as customers tend to be loyal allowing the
company to compete on advertising, not price.
- Margins around 50%
- The company has made several acquisitions and is at a
turning point where the benefits of the new products are about to kick in.
- The stock has been trading sideways for five years
- Intrinsic value Euro 7.7-8. It is a modest discount but it
is hard to find bargains in this market.
Hassan Elmasry – Independent Franchise Partners
Hassan Elmasry uses the term franchise to describe companies
that have ‘vibrant intangible assets’ like patents, trademarks, licences,
network effects and very high switching costs. These qualities give a company
an enduring competitive advantage but on top of that Franchise Partners look
for companies that combine intangible assets with very low physical capital
demands. According to Elmasry, such a
business model gives a company a license to print money.
Franchise Partners’ approach is somewhat concentrated with
20 or 30 stocks. It is also concentrated by sector as they do not invest in
financials, energy, commodities or most technology companies. Elmasry refers to
it as an ‘ultra-high quality strategy’ but one that also needs to be combined
with a search for value. Their universe is surprisingly small: only 180 companies in the world meeting their
criteria. That universe stays quite static regardless of changes in the price
of assets. Franchise Partners’ best investments have had three characteristics:
- Organic revenue growth
- Healthy margins that show improvement
- Attractive valuations at purchase
Investment idea – Kirin Holdings (TYO: 2503)
- Kirin Holdings owns Kirin brewery in Japan
- Kirin is large player in the beer market in Japan, it has
a distant No. 2 position in Brazil and is No. 2 in Australia. They also own 49%
of San Miguel.
- At the moment there is not much in the way of volume
growth.
- Franchise Partners bought their holding in Kirin in Sept
2014 between Yen 1300-1400.
- Kirin trades on an enterprise multiple EV/ EBITDA of 7, which
is much cheaper than competitors such as AB Inbev, Sab Miller, Heineken and Carlsberg.
- Management has several options that could push the share
price higher. Franchise Partners think of Kirin as a cash cow. Kirin could
divest non-core beverage assets in Australia. Sell off the pharma assets. They
could use the money from divestments to buy back shares. The payout ratio is
only 30% - the dividend could be increased.
- There is a new CEO who might bring change. Margins need to
be improved. Kirin is inefficient. A programme of simple operating improvements
would help to improve margins.
-ISS, the shareholder advisory group, has recommended that
several directors should be replaced.
Kevin Gibson – Eastspring Investments
Kevin Gibson has been covering Japanese equities for 20
years. He believes that predicting the future of markets and equity prices is
very difficult and that those who think they can gain an edge through superior
information gathering are usually wrong. There is no stable relationship to be
found between fundamentals and price. Price is much more volatile than value. Market
forecasters tend to echo backward looking observations, extrapolate
observations into a trend and then miss the market turning points.
Gibson’s answer is to deemphasise the role of forecasting
and replace it with a behavioural perspective on price formation.
Representativeness bias leads to the extrapolation of trends, overconfidence, a
focus on irrelevant information, herding and short investor time horizons. Prices get driven to extremes and then market
participants are surprised when they mean revert.
As biases are hardwired they are difficult to overcome. They
use guidelines to anchor their decision making process. Valuation is used to
search for the largest mispricings with quant screens as a starting point in an
attempt to take the human out of the process but 80-90% of their time is spent
digging deeper, trying to find the best ideas from the screens.
Investment idea – Mitsubishi UFJ Financial Group (TYO: 8306)
- In terms of price to book Mitsubishi UFJ trades at a 40%
discount relative to other Japanese banks
- Strong and diversified balance sheet
- Diversified from domestic interest rate and credit cycle –
offshore loans approx. 40%
- Foreign loans may re-price as US rate cycle normalises
- Total revenue diversified from domestic rate cycle: non-interest
income 46%, fee and commission income 33%
- Marginal cost of future revenue growth likely contained
- Surplus capital meets Basel III
- Ample scope for increase in dividends or buybacks
Gibson believes that at current levels Japanese equities are
still a buy. Real corporate change is taking place in Japan.
Charles Brandes – Brandes Investment Partners
Q&A Session. Charles
Brandes started work as a stockbroker in 1967 during the Go-Go Era – a time
when many investors thought the Nifty 50 large cap stocks were a one-way bet.
The market crash of 1969-70 left the S&P 500 down 45% and the number of
customers coming to Brandes’ brokerage dried up. One day out of the blue Ben
Graham walked into his office in La Jolla, California, to open an account and
buy a stock he believed to be undervalued. The first meeting and subsequent
chats with Ben Graham changed Brandes’ life. Value made complete sense to
Brandes and in 1974 he started his investment firm. Sir John Templeton was also
a mentor to Brandes. Templeton convinced Brandes to invest in Japan and
influenced the culture and management of his business. Sir John also offered to
buy Brandes’ investment business but Brandes told him it was not for sale.
Brandes has been a Graham and Dodd value investor throughout
his career. Like Buffett, Brandes said you either get value investing straight
away or you don’t. One area where Brandes was different from many of the other
value investing firms was that he was prepared to look beyond the US and invest
internationally. He felt that value is value no matter what country the
business is in. Being a pioneer in international investing paid off in the
1990s when US investment funds and brokerages discovered a huge appetite to
diversify. By 1998 Brandes had $100bn under management and closed to new
business. He said that in retrospect that was too much money to manage and they
should have returned some to investors. Today Brandes manages about $31bn.
Brandes’ firm takes quite a statistical approach to
valuation and running into the 2008 crisis their screens showed that banks
looked attractive. Brandes had had success investing in banks throughout his
career by buying when they traded at less than book value and selling at 2x
book but “this time was different.” One reason he gave for the difference was
the vicious circle created by mark-to-market accounting. Once the banks
marked-to-market their capital went down, they then had to raise money, which
made their stocks go lower, causing the capital to go down, requiring them to
raise more money. Asked how he avoided value
traps, Brandes said that it is a new concept that did not exist before 2000 and
besides nobody asks about growth traps….
Asked about the current market, Brandes said that today is
not like the go-go era. Things are not excessive or alarming. He is worried
about interest rates being low but thinks there are still investment
opportunities in good companies. He does worry about the growth of index
investing. He argued that if big investors go passive they are abdicating the capital
allocation role in capitalism, which will lead to inefficient allocations of
resources.
Nathaniel Dalton – Affiliated Managers Group (AMG)
Nat Dalton is the President and COO of AMG. AMG has been
listed on the New York stock exchange since 1997 and is the 9th
largest asset manager in the world by market cap. AMG has an interesting
business model. It enters into permanent partnerships with other investment
companies, which he refers to them as boutiques. These boutiques include some of best known
names in value investing including ValueAct, Yacktman, Tweedy Brown, and Third
Avenue. AMG takes an ownership share in the boutique and provide services
including succession planning and marketing. They look to acquire stakes in
outstanding investment managers with excellent track records. Historically they
have paid 8-10x EBITDA for investments in new boutiques. The affiliates are
autonomous and Dalton says AMG does not ‘screw up’ their businesses.
Dato' Cheah Cheng Hye – Value Partners Group
Value Partners are a Hong Kong listed asset manager with
$14.7bn AUM focused on value investing in Asia. The flagship fund has returned
16.4% annualised since 1993 against the Hang Seng Index’s 8.6%. Cheng Hye
started out as a Graham and Dodd investor but evolved to place more weight on
the influence of politics on business in Asia. The ‘3 Rs’ are important in
Asia: the right business, the right people, at the right price. Asia has policy
driven markets. If government is against something avoid investing in it.
However, in areas like renewable energy, healthcare, and the environment, good
investments can be found by working out which companies are favoured by policy.
He encourages his employees to assume that they are stupid as then they might
then do clever things (that’s better than the other way around). Value Partners
runs diversified portfolios. In order to manage more money effectively he has
divided his team into clusters of 4 to 8 people.
An equity culture has not developed properly in China yet
with the total number of stockbroker accounts only on par with Brazil. Chinese
people are under-invested with only 6% of their wealth in the market. There is
a general feeling of mistrust of stock markets because people have had their ‘fingers
burnt.’ The recent dramatic rally in China stocks has further to go. The Hang
Seng China trades on a forward PE of 9.8, 1.3x PB. There is an opportunity to
invest in the ‘H’ shares as they trade at a 30% discount to the ‘A’ shares. It
might be better to invest in larger companies as small-caps have already had a
good run. He warned that ethical standards were low on the mainland. Investors
have to do lots of due diligence but the market is inefficient so there are opportunities.
Looking to the future, in the context of policy driven markets investors should
watch out for 8 big government reforms. 1. Deregulation – the use of ‘negative
lists’ listing out what cannot be done, meaning everything else can be done. 2.
Opening up. 3. Financial liberalisation. 4. Land and Hukou (household
registration system) reforms. 5. Resource pricing reforms. 6. State owned
enterprise reform. 7. Social security reform. 8. Relaxing the one child policy.
Simon Denison-Smith - Metropolis Capital
Investment idea – Regus (LON: RGU)
Regus is a global market leader in the provision of serviced
office space. It is trading on a PE of 36x and at a 14 year high - not an
obvious value investment – but growth can be a component of value. When Regus
opens new offices it take two years for them to breakeven and 4 years to reach
full potential. The development of new offices hides future performance.
- At £2.50 Regus trades at 10x normalised (through cycle)
post tax cash flow.
- It has negligible debt, 0.5x EBITDA.
- Regus is 13x larger than its nearest competitor.
- Growing at 20% per annum and has been able to redeploy
capital with a 20-25% return on investment.
- Intrinsic value without growth £3.70; with 10% growth
£4.70; 15% growth £5.20.
- Regus is “owner occupied’: founder CEO, Mark Dixon owns
30% of the stock. See our notes from last year’s London VIC where Jonathan
Mills of Metropolis explained the
advantages of ‘owner occupation’.
Regus has a moat that comprises the sum of lots of small
advantages:
-Dominates in internet search
-Global clients like TATA, Google and Toshiba like Regus
because they are the only global player
- Add-on services produce 40% of revenue
- Network effect delivers better landlord deals
- Scale advantage in management and procurement
- Knowledge advantage in new office selection
Denison-Smith noted that there were aspects of Regus’s
business model that they found harder to like. It is an operationally geared
business in a highly cyclical industry that has been a roller coaster ride for
investors. The US part of the business
had to be put into Chapter 11 in 2004. During the credit crunch, operating
profits dropped by 70% from 2008 to 2010 with the UK business falling into a
loss. Denison-Smith believes that Regus will perform better in the next downturn
because they have signed leases within a SPV for 90% of its offices. This
approach had been implemented in the US part of the business before the credit
crunch and despite a fall off in office rents in some cities of as much as 50%,
the US business remained profitable throughout.
Kevin Murphy – Schroders
After the popping of two equity bubbles in the last 15 years,
everyone seems to want to invest in Warren Buffett style, high quality, stable
free cash flow businesses that have a moat. These companies appear to offer low
volatility and are comforting for clients but they do not offer safety at
current valuations. Murphy prefers Ben
Graham’s approach of buying the cheapest items in the shop although he also
noted that whichever value approach you adopt the most important thing is to
stick to it and do it consistently.
Investment idea – Lonmin (LON: LMI)
Murphy noted that following Ben Graham and buying the
cheapest items was often uncomfortable and as if to illustrate that he pitched
aluminium miner, Lonmin. Aluminium is
mainly mined in South Africa, Zimbabwe, and Russia – not the most economically
or politically stable countries. Commodity businesses are highly cyclical.
Platinum is rarer than gold but unlike gold it does have some industrial uses
including as a catalyst in catalytic converters. In 2007, platinum was the most
valuable commodity and Lonmin had profit margins of 44% and price to tangible
book was 4.9x. Times change, excess supply, weak end-demand, poor labour
relations and a difficult political backdrop have all contributed to Lonmin
screening as one of the cheapest stocks in the UK market. It now trades at 0.5x
tangible book. There have been three rights issues since 2007 and now Lonmin
only has a small amount of debt.
The majority of platinum, about 80%, is mined in South
Africa. That is a good thing as all the aluminium miners face the same supply
situation and the same labour relations challenges. They cannot rely on a third
party in a different country to fix the supply and demand problem for them. The
largest producer has been reducing production.
Murphy said that the job of the investor is not to look at
today’s problems but to ask a simple question: “What if?” What if platinum
jewellery becomes fashionable again?
What if European car makers make a comeback? What if Lonmin’s share
price reverts to its 10 year average? The
answer to the last question, said Murphy, was that the stock will double. Kevin Murphy and Nick Kirrage run a value
investing blog called The Value Perspective
Bernd Ondruch – Astellon Capital Partners
Investment idea – Volkswagen (ETR: VOW3)
VW is one of the cheapest large companies in the world based
on PE. It trades at a 42% discount to the average holding company. Ondruch
believes that there is 60% potential upside and a substantial margin of safety.
Ondruch argued that there are a number of good reasons why
VW has only traded at book value for 70% of the time since the 1990s. VW has
been plagued by governance issues. Management have been rightly criticised for
empire building, pursuing vanity projects and for poor capital allocation
decisions. They paid too much for the
truck manufacturer, Scania. Over the last 20 years, the company has spent about
Euro 30bn on M&A. Post dividends, the company has generated negative cash
flow. The voting rights are dominated by an alliance of families who have an
asymmetrical advantage. The free float
accounts for 40% of the capital but only 12% of the voting rights. Conversely,
the Porsche family control 32% of the shares but 51% of the voting rights.
Ondruch says the company is at a major inflection point.
With the recent exit of the Chairman, Dr Piech, VW can become a more normal
company. Ondruch argues that there are 4 levers of value creation that will now
be important if his investment thesis is to play out. Firstly, the Euro 5bn
modularisation efficiency programme announced in October which allows different
models to share common parts and be built on the same production line should
increase margins. Secondly, a programme has already been started to reduce the
deep discounting of car prices in Europe. Thirdly, the Ferrari IPO highlights
the value of Porsche. Ondruch thinks that Porsche has a brighter future than
Ferrari because it will benefit from economies of scale by staying with VW. Finally,
expect a demerger of the truck business via an IPO in the next two years.
Jeff Everett – EverKey Global Equity
Jeff Everett was part of Sir John Templeton’s research team
and went on to serve as president of Templeton Global Advisers. He spoke about
the insights that can be gleaned from studying Sir John’s approach. Sir John
was the first behavioural investor, independent in thought, adaptive and
visionary. In-depth research was his hallmark. Sir John built up micro and
macro data sets and was data driven at a time when few others were. Using data
that he compiled he was able to predict the rise of Japan’s productivity and
export industries as early as the late 1950s – well before others thought it
was possible. Sir John was a long-term investor and did not turn his investments
over quickly like many of today’s fund managers. He advocated a concentrated
approach dominated by equities. He encouraged his investment managers to hold a
total of around 10 stocks each.
Ivan Martin Aranguez – Magallanes Value Investors
Before co-founding Magallanes, Aranguez worked at Santander
AM, Aviva, and Sabadell Gestion where he delivered superior returns in Spanish
and European equities until mid-2014 of +300% and 45% respectively for the last
12 and 5 years, considerably outperforming the benchmarks. After top Spanish
fund manager, Francisco Garcia Parames, left Bestinver last year he recommended
Aranguez as the best person to invest with in Spain.
Investment idea – Hornbach
Hornbach is a family owned company. The family hold 100% of
the voting shares with 50% of the capital. There are two separately quoted
companies in the Hornbach group: Hornbach Holding (ETR: HBH3) and Hornbach
Baumarkt (ETR: HBM). Hornbach Holding has a 76.4% holding in Baumarkt. Aranguez recommended both companies but said
that Hornbach Holdings is more complex and maybe cheaper.
Hornbach Baumarkt is a DIY store operator and the most
important part of the Hornbach business. It operates the 3rd largest
chain of DIY stores in Germany with 99 stores. They have 146 stores in 9
countries and are the 5th largest DIY stores operator in Europe with revenues
of about Euro 3.3bn. The DIY stores business is very tough and competitive with
low margins. Praktiker (one of their largest competitors) filed for bankruptcy
in 2013 reducing the competition a bit and creating a more profitable
environment for the survivors. Despite the competition in the sector, Hornbach
Baumarkt has been a consistently successful business over the years. It has a
number of competitive advantages:
- It is a service-orientated company that has generated
loyalty from customers
- They are the low cost operator in the DIY sector
- Baumarkt’s megastore concept offers the widest range of
products to customers with low risk of running out of stock.
Hornbach Holding has hidden assets – large real estate
assets carried at book value with no accounting for rent. Baumarkt trades on an
enterprise multiple of EV/ EBITDA 9.5x with upside potential of 52%. Hornbach
Holding has an EV/EBITDA multiple of 8.5x with an upside potential of 61%. At
the next owners meeting, a proposal to simplify the organisational structure of
the company will be considered. The capital structure could be simplified to
merge common and preferred shares. Hornbach is a good play on the recovery of
the German consumer. Three quarters of
German housing apartments are more than 30 years old, ensuring ongoing demand.
