Value Investing Congress Blog

Vitaly Katsenelson- portfolio manager with Investment Management Associates and author of Active Value Investing, laid out his rationale for suggesting that markets are currently range-bound, and will continue to be so for the foreseeable future:

• Range Bound Markets are caused by valuation
• Interest rates are secondary
• Profit margins are near all time highs, and will revert
• As margins decline, the “E” in P/E will also drop, P/Es will rise
• Profit margins in most sectors will decrease
• Stocks are not currently cheap
• In range bound markets, careful stock selection is paramount

Katsenelson’s favorite idea is clothing retailer Jos A. Bank (JOSB)

• $420 million mkt cap, no debt, $80 million in cash
• Great service, quality at a reasonable price
• Wall Street hates the stock because of low inventory turnover, and the fact that management communicates terribly
• Despite pulling back considerably, returns on capital, and net margins are still rising to historic levels
• Currently trading around $25.50, Katsenelson believes the stock could be worth $41-$53

Next up were Atticus Lowe and Lance Helfert from West Coast Asset Management who run very concentrated portfolios, and look for the following: Margin of safety, catalyst, management quality and strong cashflow. They caution against the classic value trap, and getting sucked into ideas that appear cheap, but are actually facing obsolescence. They suggest that value investors take it upon themselves to:
• Observe like-minded investors- see what the managers you respect are buying
• Attend special events for ideas and information (trade shows, Value Investing Congress, etc)
• Observe businesses first hand—speak to suppliers, employees, management
• Use stock screens

Lowe and Helfert’s best idea is gas company Canadian Superior Energy (SNG)

• $500 million mkt cap
• Western Canada and Trinidad operations worth $500 million alone
• Catalyst is recent discovery in Trinidad—80,000 acres, offshore natural gas field, which, if successful may put the company value from $10-$15/share (currently $3.50).
• British Gas experience and involvement will help
• Value not dependent on soaring natural gas prices

Jonathan M. Heller, CFA

The 3rd annual Value Investing Congress West kicked off today with an introduction from co-founder John L. Schwartz, MD. Each presenter discussed their investment philosophy, addressed current market issues, and then highlighted specific investment ideas.

First up were Mark Sellers and Victor Fasciani from Sellers Capital LLC, whose Sellers Capital Fund has booked an impressive 36% annualized (net of fess) since inception. Seller’s runs a highly concentrated portfolio of companies with what they believe to be “wide moats”.

Sellers and Fasciani presented the case for Vulcan Materials (VMC, $66):
• Demand for aggregate materials (asphalt related) will grow as US infrastructure (bridges, roads, etc) are in need of repair.
• The aggregate industry suffers from the “Not in my back yard” syndrome, so new mines are not being opened quickly enough. Plus, it takes five years, an onerous amount of permits, and $100 million to open a new mine.
• With growing demand for aggregate material, and desperate needs for infrastructure improvements in the US, Vulcan is well positioned to be a beneficiary.
• Sellers and Fasciani believe the stock is worth at least $90.

Next up was Jeff Bronchick from Reed Conner & Birdwell, LLC. Bronchick seems never afraid to speak his mind, which makes him a very entertaining speaker. Among other things, Bronchick brought forth the notion that value investing is far from an exact science, and while it is successful over time, it does not work in every time period. On the subject of the credit crisis, Bronchick suggested that the situation may not be as dire as it appears, and took aim at industry execs that still have their jobs despite terrible mismanagement.

Bronchick’s main focus was AIG:
• Company is unfairly tarnished, and has been punished by headline risk
• Has never been cheaper at 8 times “depressed” earnings
• Has $13 billion in excess capital
• Potential write-offs are very small given the company’s large asset base
• Company has plenty of staying power

Bronchick also addressed GE, suggesting that management needs to, among other things, drop quarterly guidance, stop selling businesses at book value, then paying dearly for other businesses, and buy back stock and/ or increase the dividend.

Jonathan M. Heller, CFA
*Author does not own any securities mentioned

The afternoon session was chock full of practical value investment techniques, applicable to real situations. Here are just a few of the highlights:

Washington Mutual
Having already stated their belief that the mortgage crisis is not over yet, Whitney Tilson and Glenn Tongue presented a negative view of WAMU (they have a short position):
• The concern centered on HELOC exposure (home equity lines of credit), junior liens, and option Arms. In the case of option ARMs, 62% of exposure came from two of the most challenged markets: California (49%) and Florida (13%).
• Tongue expected the company to lose $5 per share this year
• Significant shareholder dilution occurred when the company issued $7 billion in stock in April
• Tongue stressed the importance of doing your homework -and having a working model to assess true exposures -when taking a position (either long or short) in a company such as WAMU.

Retailers:
Tilson suggested that although now is not the appropriate time to be long a basket of retailers given the current economic situation, there are some bargains out there. He presented a bullish (and compelling) case for Target (TGT):
• buying back stock ($10 billion buyback program)
• selling credit card ops—(interestingly enough, the news of the sale of 47% of this business to JP Morgan for $3.6 billion broke during the conference)
• Owns a large percentage of its land and buildings—real estate alone may be worth 70-80% of current market cap
• Potential $5.00/share eps 3 years out (stock currently $53)

Tongue presented the bullish case for Sears Holdings (SHLD):
• Repurchased 33 million shares the past 3 years
• Sum of the parts potentially worth a great deal more than current market cap ($13 billion)
• Real estate alone- 250 million square feet- currently being valued at less than $10/sq ft assuming conservative $11 billion valuation of business units
• Trading at significant discount to current $100 price

Other Highlights:
• Bearish on Allied Capital (ALD -short position)—company surrounded by controversy, and may be a house of cards ready to fall.
• Bearish on Crocs (CROX- short position)—which may be a textbook version of a fad stock—explosive growth, unsustainable margins, and no competitive advantage, all of which is a road to nowhere.

Tilson and Tongue put on a great seminar—well worth the price of admission, and highly recommended to anyone who wants to learn practical applications of value investing taught by successful professionals who practice the art each and every day.

I’m back in Southern California for my second Value Investing Congress West (May 6th and & 7th), and this year I’m also attending the Pre-Congress Workshop, An Advanced Seminar on Value Investing, taught by T2 Partners’ Whitney Tilson and Glen Tongue.

As a CFA Charterholder with an MBA, a small financial advisory practice, and 20 years in the business, I’ve been in my share of classrooms over the years.

Tilson and Tongue’s detailed, fast moving, but equally understandable instruction style make this pre-Value Investing Congress session well worth attending.

Morning Highlights McDonald’s
An excellent case study on the fate of McDonald’s (MCD) following the company’s 2003 bottom opened today’s session. Tongue recounted a previous analysis of the company which argues against viewing McDonald’s as merely a quick service restaurant company, preferring to characterize it as a Brand business (including real estate and franchises) and a restaurant company with more than 8000 company owned stores. This is the way that we, as value investors, are trained to think. A little reinforcement here is never a bad thing.

The restaurant business is much more complicated than one might think, and Tongue and Tilson’s insights on the industry as whole, and a few of the players, were extremely valuable.

Berkshire Hathaway
Tilson and Tongue are still unapologetic Berkshire proponents, and put the current intrinsic value of the A shares at nearly $180,000 per share, a 40% premium to the current price. (Interestingly enough, the audience at today’s session was polled, and at least half were at last week’s Berkshire annual meeting!)

The Mortgage Crisis
For his part, Tilson believes that we have not yet seen the worst of the mortgage crisis. His extremely detailed presentation (“An Overview of the Mortgage Crisis and the Structure of CDO’s”) paints a very bleak picture, suggesting that all things housing and mortgage related will get much worse before improving. Tongue and Tilson put their money where their mouth is with short positions in monoline insurers AMBAC and MBIA, and a long position in Fairfax Holdings (which has gained and may gain further in the mortgage crisis due to its credit default swap holdings).

Jonathan M. Heller, CFA