Contrarian Favorites: Freeport and Loews

09/18/2015 10:00 am EST

Focus: STOCKS

Adrian Day

Chairman and CEO, Adrian Day Asset Management

Focusing on value and quality, contrarian expert Adrian Day often sees opportunity when others are fearful. Here, the editor of Global Analyst explains his long-term investment strategy and highlights two out-of-favor stocks which he believes offer solid long-term value.

Steven Halpern: Our guest today is Adrian Day, global money manager and editor of Global Analyst, and a long-standing expert on resource and commodities stocks.  How are you doing today, Adrian?

Adrian Day:  I’m fine, thank you.  How are you?  

Steven Halpern:  Very good. Thanks for joining us. As a value expert, you’ve never been afraid to step in and buy when others are fearful. In part, that’s due to an investment strategy that emphasizes patience, quality, and value. Could you explain to listeners how those factors play a role in your long-term strategy?

Adrian Day:  That’s an interesting question, you know, a big question.  You know, there’s obviously different investment styles and I tend to be someone that likes to pick good companies, run by good people, with good assets, and so on, but are selling at a low price, as they—and I like to hold them for a long period of time—now, as a long-term value investor, you know, one needs patience because you never know when that turn is going to come.  

By its nature, you’re buying things that are out of favor and you obviously hope that—or look for a catalysts—but there may not be an immediate catalyst, and of course, value investors, including myself, are notoriously early at picking things.

But if you pick good companies and you can afford to hold on, that’s fine, so patience is critical, because if you’ve got a good quality company, the worst thing you can do is panic at precisely the wrong time.  

Steven Halpern: I assume knowing that it’s a high-quality company gives you comfort that you could hold it through those ups and downs.

Adrian Day: That’s correct, that’s correct.  

Steven Halpern:  Now, you’ve recently taken a contrarian position by suggesting that investors buy two stocks that have been facing very strong headwinds from lower resource and energy prices.  Now, the first of those is Freeport-McMoRan (FCX).  What’s the story here?

Adrian Day:  Yeah, first of all, you mentioned energy, and I should just say: I am not a great bull on energy prices in the short-term, and by short-term, I mean six months, 12 months.  

I mean, I don’t think the world has cut enough supply given where prices are, so I’m not a great bull on that, and so obviously, given the turmoil in that sector, there are some great companies whose stock prices have declined significantly.

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And so, as a contrarian, that’s a good place to be looking, but because I’m not a great bull, I’m preferring to steer away at the moment from pure energy plays and look for companies that have very high exposure and leverage to energy but aren’t 100% dependent upon it, so if you look at Freeport—and I’m sorry for the long—but Freeport is actually the largest publicly-traded copper company. Copper represents approximately half of their revenue at the moment.  

Now, a year and a half ago, more or less, they bought two oil and gas companies, one of which was an affiliated company—or a company I should say that shared some management and directors—called McMoRan Exploration.

And the company took on debt to buy it, so this was a very controversial move because of the, you know, affiliation between the companies.  

In fact, they used to be one company and then they split, so that was one thing, but the second thing was that they took on an enormous amount of debt to do it. With the decline in both copper and oil prices, they’ve both come down significantly.  

You know, that has taken their debt to extremely high levels. In fact, the debt—well, now the stock price has rallied a little—but last month the debt actually was twice the market cap of the company, which is quite significant.  

Steven Halpern: So from a long-term standpoint is that is there a time to be looking?

Adrian Day: I think so and the reason I say that is because first of all, Freeport is, as I said, it’s the world’s largest publicly-traded copper company, but it has some world-class copper mines.

It also has what would be—if it were standalone—the world’s largest gold mine, a lot of oil exploration upside in the Gulf, Gulf of Mexico, that is, plus it’s the world’s...one of the world’s leading producers of both molybdenum and cobalt, two high-value commodities, so it’s a company that, in the resource space, is, you know, a world-class company.  

It has taken on debt before. Normally, Freeport runs a very clean balance sheet. It has taken on debt before to make acquisitions and it has always had the goal in those circumstances of paying down the debt as quickly as it can from cash flow.

It’s just that they took on debt at this point at precisely the wrong moment, just before the prices of copper and oil collapsed, but the leverage in the stock is extremely high.  

I mean, you look at their earnings for example: This year, 35 cents in earnings, four years ago, $4.83 in earnings.

So, and even last year their earnings were $2 a share, so you don’t need an awful big move, you don’t need to go back to record high levels to see significant leverage, and then the cash flow stuff coming in and they’re able to cut their debt significantly. They’ve done it before and I’m comfortable.

Steven Halpern:  Now, another stock that you’ve recommended for a long time that’s also been suffering from some headwinds is the conglomerate Loews (L). Could you share some background on this situation?

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Adrian Day: Yeah, and again, you’ve introduced by saying two companies in energy. Loews, obviously, is not an energy company. Its largest holding at the moment is CNA Insurance (CNA), but two of their large holdings are actually energy-related.  

One is Diamond Offshore (DO), the drilling company, and they focus on—or emphasize—deep ocean drilling, so clearly, drilling companies are significantly hurt when the price of oil goes down because companies start cutting back on their exploration, so Diamond Offshore has been hurt.

And the other company is a pipeline company, Boardwalk Pipelines (BWP). Again, this has been hurt because of the recent discovery and increased production of shale in the northeast.

Then there’s less demand for shipping oil from the Gulf of Mexico up to the northeast, which is where most of Boardwalk’s pipelines go, so that’s seeing reduced volumes.  

Now, you know, one has to say that Loews is quite a different company than Freeport. It is not a resource company, doesn’t pretend to be a resource company. It has other assets including, say, Loews Hotels, that people will have heard of, but Loews are contrarian investors.  

They typically buy things that are out of favor, and so, thus, they’re exposed to the energy sector right now. The other major difference between the two of them, Steven, is that Loews has an extremely solid balance sheet. It’s got over $5 billion in cash—net cash—at the holding company level.

And so Loews, as it has said publicly, stands ready to support its units, in this case, Diamond Offshore and Boardwalk. And, in fact, not only to support them through the difficult times but to give them—or lend them, I should say—the money to make acquisitions when it looks like the sector’s going to turn.

So they will be in an extremely strong position—where the rest of the industry is divesting products or assets—they will be in an extremely strong position to pick those assets up.

Steven Halpern:  Now, you’ve also looked at the stock from a sum of its parts standpoint. Could you explain that?

Adrian Day:  I think that’s the way to look at a company like Loews—really, any conglomerate, that’s the way I look at it—so most of Loews units are publically trading. I mentioned CNA and Diamond Offshore, as well as Boardwalk.  

They’re publicly trading, so you just look at whatever the price of the stock in the market, you don’t even attribute a control premium, which you normally would do, since Loews is a control in all three companies, but you just look at the shares—the value of the shares—the value of the cash is the value of the cash,.

And then with an estimate of Loews and other sort of small, private holdings, with a fairly conservative estimate on those, you get to an over 30% discount, about a 33% discount to the sum of its parts.  

Now, conglomerates always trade at a discount, but that is an extremely high discount for any conglomerate, especially for Loews, with such a strong balance sheet, so yes, it’s a perfect play for a long-term, patient, contrarian investor.  

Steven Halpern:  Again, our guest is Adrian Day, editor of Global Analyst.  Thank you so much for your time today.  

Adrian Day:  Well, thank you, Steven.  Thank you.

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