Mike McGarr, co-portfolio manager of Becker Value Equity, explains the strategy behind the Morningstar 5-star rated fund and highlights a trio of stocks that meet his value investing criteria.
Steven Halpern: Our guest today is Mike McGarr, co-portfolio manager and analyst with the 5-star rated Becker Value Equity Fund. How are you doing today, Mike?
Mike McGarr: Very well Steven, thank you.
Steven Halpern: Well, thank you for joining us. Becker is well known as a boutique firm that generates its own stock ideas separate and apart from Wall Street. Could you tell our listeners a little more about Becker in general and, more specifically, the investment strategy at Becker Value Equity?
Mike McGarr: You bet. Yeah, well, just by way of background, Becker Capital Management was founded in 1976. We've grown steadily in terms of assets under management and people to the point where we're currently managing about $3.2 billion and our Becker Value Equity Fund has about $340 million and is 5-star rated by Morningstar and we fall into that category of value investing.
It is an approach that we've used since the inception of the firm. What we're trying to do is identify companies that are out of favor with the market as measured by, oh, recent trading performance. You know, we're going to look for the laggards in the market. We're going to look for changes to the negative, in terms of Wall Street and analyst sentiment.
Then, valuation also figures importantly into that as our founder Pat Becker, Sr. used to famously say, "It's not enough to identify a good company, what you pay for it has tremendous implications for your subsequent return." Yeah, we're looking for companies that are out of favor but out of favor for what we believe will prove to be transitory reasons.
We're not deep contrarians and we're not turnaround specialists. We'll leave those specialties to others. We're looking to develop some conviction that a company's problems and the reason for it being out of favor are likely to prove temporary, whether it's related to a product cycle, or management turnover, or the economic cycle, something like that.
What we try to do is build what we refer to as a weight of the evidence case for including a stock in the portfolios at a particular price. We're going to look at balance sheet integrity. We don't like to layer on financial leverage on top of operating leverage.
We're going to look at the level and direction of operating margins, cash flows, capital structure, and importantly we focus on a company's return on invested capital and their ability to generate a decent return over and above a conservatively-estimated cost of capital.
That tells us that they're efficient with their capital, that they're actually creating shareholder value. We run about 60 to 65 names in our portfolios. That, in a nutshell, is how we approach the markets.
Steven Halpern: As we speak, the market is trading near all-time highs. Does that make it more difficult for your value approach or do you believe the market's higher valuations actually argue in favor of a value fund?
Mike McGarr: Well, yes, the market, by our measures, and one of the indicators we like to look at is that median PE ratio for the S&P 500 and it's about 20 times on a trailing 12 month basis right now, so yeah, it is definitely more challenging to find new and compelling ideas.
|pagebreak|We are finding them and it tends to be an eclectic bunch and-as to value investing at this juncture-yeah, we would tell you that it's been our experience that it's a well selected portfolio of stocks with generally lower expectations-and that's generally the case with value investing-and reasonable valuations can be a pretty effective means of protecting capital for what.you know, I can't tell you when we're going to see a pullback.
It's been a long time since we've had any sort of meaningful correction but inevitably there is going to be one and value investing has proven to be a good way to protect capital in that sort of an environment.
Steven Halpern: Let's talk about some specific investment ideas that will help highlight the overall approach of Becker Value Equity. One idea you've highlighted is Plum Creek with the symbol (PCL). What's the story there?
Mike McGarr: Plum Creek is very much an asset story for us. The company trades at about $41 currently. They're headquartered in Seattle. It's a management we've known for quite some time. They are one of the largest timberland owners in the United States with some 6.8 million acres of timber under management and it has a market capitalization of about $7.3 billion.
Shares have lagged for the better part of a year on concerns that the domestic housing market has been flagging a big; also, some of their export markets. They send a lot of saw logs to Asia and also to Europe and there is concern that, with potential weakness in those markets, that results could be impaired.
When we make very conservative assumptions about the acreage values for Plum Creek we can come up with an enterprise value north of $9.5 billion. You take out the debt and you've got a stock trading in the upper 40s and very solid cash flow. The dividend, which currently yields, and the shares currently yield about 4.3%, the dividend is well covered.
There's another thing that any value investor is going to love about a name like this and that is that the trees grow about 7% a year and who doesn't like that? We think it's an asset play that's not fully appreciated by the market. There's still good demand for housing and that's what we're looking for. We think the shares could rebound to the high 40s without too much trouble.
Steven Halpern: Now another idea you've highlighted is Western Union (WU), a very well-known company that doesn't seem to have gotten a lot of attention lately. What's happening there?
Mike McGarr: Well, that's right, yeah, the shares have lagged for the better part of three years. It is a well-known name. Some 160 years, originally in telegrams, telecommunications but now they are the largest money transfer company in the world. Market capitalization of about $9 billion.
They've got some half a million agents in 200 countries, another 100 thousand ATMs scattered around the world and they are the largest money transfer business in the world. The shares have lagged, oh, for a variety of reasons. There's been concern about potential new entrance into this business. Some people have mentioned companies like Visa getting into the business, but that's a very different business that they're in, and we don't think they see attraction in this.
|pagebreak|Then you may have also read that Wal-mart was going to get into the transfer business and certainly Wal-mart will garner some portion of the market but they would probably find it extremely expensive to try and duplicate the Western Union network.
Then there's also concern that there'll be some technological disintermediation as people start to use smartphones more and more to make their transfers but the appeal to this is that most of those threats really only affect in-country transfers and when you start moving across borders it gets a lot more complicated from a technological standpoint and from a regulatory standpoint.
Western Union has made the necessary investments in terms of compliance to make sure that they're not engaged in or party to fraudulent transfers or money transfers in support of terrorism or money laundering and that sort of thing; and they've got a lot of that spending behind them.
And so, we think margins are set to start to expand again and, using fairly conservative assumptions, we can get to $1.45 to $1.50 for this year with the stock at about $17; that's only about 12 times earnings in a market that's considerably more expensive.
We think they can do something on the order of $900 million of free cash flow, so that's; gosh, that's almost a 10% free cash flow yield. This is a company with a strong, recurring revenue and cash flow based trading at a very reasonable valuation so we've been including that in the portfolios here lately.
Steven Halpern: Now, finally, we only have a minute, but you pointed to the pharmaceutical giant Pfizer (PFE). What's the attraction there?
Mike McGarr: Well, we started to accumulate the shares
of Pfizer. It's well known as one of the largest pharmaceutical companies
in the world. We started to accumulate these shares following their failed
attempt to buy AstraZeneca in the UK. We thought that really rattled the
market, that the company was going to make some ill-conceived moves in terms of
capital deployment and they do have a bit of a reputation over the years in that
area.
They made the acquisition years back of Warner Lambert, locked
in years of shareholder dilution so some of the history there was a little bit
checkered but we like the new CEO, we think he's very shareholder oriented and
that the game plan longer-term is to divest businesses and break the company up
and really some of that shareholder value you already saw-better than a year
ago-the spinout of the animal health division.
So, this is a company again, gosh, using very conservative assumptions you can get to something north of $2 of earnings with the stock at 20 times; it's one of the cheapest in the group. $15 billion of free cash flow so they have a tremendous amount of flexibility in terms of supporting the dividend and making share re-purchases. Yields about 3.5% and for value investors this just looks like a pretty compelling idea.
Steven Halpern: Well, we really appreciate you taking the time today and sharing your insights. Thanks for joining us.
Mike McGarr: You bet, Steven, thanks very much for the opportunity.
