150 To 200 Basis Points Of Outperformance In Down Market For Large Cap Value Fund; Portfolio Manager Shares His Ideas For Financials, Pays Emphasis To Capital Preservation
December 19, 2011 - The Wall Street Transcript has just published Large Cap Value and Other Investing Strategies Report offering a timely review of the General Investing sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Edward O'Connor, CFA, is a Partner and Analyst/Portfolio Manager at Cooke and Bieler. He graduated cum laude in economics and philosophy from Colgate University. He served as a U.S. diplomat in Cuba and Guatemala prior to receiving his MBA with concentrations in finance and international business in 1999 from the University of Chicago. Mr. O'Connor then joined Cambiar Investors in Denver, Colo., where he worked as an Equity Analyst and Portfolio Manager, and participated in Cambiar's 2001 management buyout. He joined Cooke and Bieler in 2002.
TWST: What are some of your top investment picks or investment ideas right now?
Mr. O'Connor: An example of what we were just talking about is State Street (STT). It's a big custody bank. Financials generally aren't a dominant part of our Large Cap Value portfolio, because money tends to be a very commodity business. You only care about the interest rate you're paying for a loan, you don't care who's giving you a loan. Similarly on the deposit side, people are very price sensitive. So it's a very commodity business. State Street, however, isn't a bank in the sense that they don't make much of their money from commercial or real estate loans. They're really a trust bank, making most of their money from their custody business. They make most of their money providing services - record keeping, custody services, security lending services - to mutual funds and other institutional investors. It's a great business model, not terrifically capital intensive.
Demographic and market trends for the long term are in their favor, so it's a business that's likely to continue to grow for some time. There have been some concerns about pricing in some ancillary services, and to some extent they get caught up in concerns over financial regulation and capital requirements and just a general aversion to anything labeled a bank, so it's given us an opportunity to buy what we think is a great company at an extremely attractive valuation.
TWST: Would you share another?
Mr. O'Connor: Another one, again a sort of typical Cooke and Bieler theme, would be RockTenn (RKT), which is a maker of corrugated cardboard and other paper products, based just outside Atlanta, Ga. The paper industry is not a very exciting industry; however, people are always going to need cardboard boxes, so it's not going away anytime soon. It grows in line with GDP. It's an industry that historically had been subject to long periods of overcapacity and really mediocre returns, but it's largely consolidated in the last 10 or 15 years. Now the top four players control almost 80% of the market between them, resulting in more pricing discipline. And RockTenn was fortunate and skillful in that they entered the last downturn with a very clean balance sheet and made it through relatively unscathed.
One of their larger competitors, Smurfit-Stone, was forced to declare bankruptcy. This was a case where you had what was a pretty good business in Smurfit-Stone, it just had a really bad balance sheet. They made some investments they needed to make right before the downturn, and unfortunately the capital cost of the investments forced them into bankruptcy. So coming out of the reorganization, RockTenn was able to acquire them. The old Smurfit-Stone shareholders paid for these investments, and the current RockTenn shareholders will get the benefits of these investments, so we're very happy with that. America has a cost advantage in corrugated cardboard because of our supply of softwood trees. That presents an embedded competitive advantage for RockTenn. We are very excited about the stock. We could easily see it generating $10 a share in free cash flow, for a stock that is trading under $60 today, and we started buying it more cheaply than that. Fair value is around $90, so we are very excited about RockTenn.
TWST: What's your general outlook for next year?
Mr. O'Connor: We always approach it from a fundamental basis, so we know there are a lot of worries, and it's hard to know what the Europeans are going to do and what the impact on our side of the Atlantic will be of whatever it is the Europeans do. But if you look at the businesses we own and the businesses we follow, they seem really well positioned. Everybody took a lot of costs out during the downturn. Profit margins have come back, remarkably strongly in the cases where revenue has. The financial companies we follow are all much better capitalized now than they were three or four years ago, so they are much better positioned to absorb any European shocks. So building from the ground up, we're cautiously optimistic about the economic environment in general and stocks in particular for 2012. Things aren't as screamingly cheap as they were in 2009, but we don't see things being overvalued. We think there is a lot of opportunity for patient and careful investors.
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