Fort Pitt Builds Values with Unloved Equities
09/21/2015 10:00 am EST
Charlie Smith, of Fort Pitt Capital, describes his role as being an "owner of companies, not a trader of stocks." Here, he explains his long-term value-oriented strategy and highlights some of his favorite "unloved and underappreciated" investing ideas.
Steven Halpern: Joining us today is Charlie Smith, CIO, founder, and manager of the Fort Pitt Capital Total Return Fund (FPCGX). How are you doing today, Charlie?
Charlie Smith: I’m well, Steve; how are you?
Steven Halpern: Very good. Thank you for joining us today. Now, you’ve got over 30 years of experience in the investment industry. Can you tell our listeners a little about your background and investment strategy and a little about Fort Pitt Capital Group?
Charlie Smith: Sure, I’d be happy to. I started in the business in 1983 as a research analyst working for a gentleman by the name of Ron Muhlenkamp who I’m sure some of your listeners are familiar with.
Steven Halpern: Yes, he's very well-known.
Charlie Smith: I worked for Ron for the first nine years of my career and then went out into a local money management firm in 1990-1991 and then we formed Fort Pitt Capital Group in 1995.
We’re just celebrating our 20 years here at Fort Pitt and we manage about $1.8 billion for maybe 1,100 clients.
The approach here, really, is all about well run businesses, and reasonable prices, and hold onto them. We define a well-run company as a company that has return on equity equal to or greater than the industry average.
Reasonable prices...we’re looking for a price-to-book multiple that’s below the industry average, so if we can get a good business at a reasonable price and then hold onto it, that’s been what we’ve used to build our portfolios over the years.
Steven Halpern: As a value investor, you emphasize that you want to be an owner of companies rather than a trader of stocks. Could you expand on this?
Charlie Smith: Yeah, certainly. Now, wealth isn’t created in a week or a month and a lot of people get caught up in the idea that they can play the game of Wall Street; the idea that you’re going to get a piece of information sooner than the other guy or trade faster than the next guy and be able to buy high and sell low repeatedly. We think that’s really a loser’s game.
It really is actually a negative sum game. Contrast that with owning a portfolio of businesses that you hold over a multi-year period, which is very much a positive sum game. We have very liquid and deep capital markets here in the United States and that allows us to participate as business owners in a diverse portfolio of companies which we own for an extended period.
The best metric for our investment approach, really, is our average holding period is about eight years for the companies that we invest with, so we really are owners of the businesses rather than trading blips on a screen or trading pieces of paper.
We found that if you can go out and find a well run business that you can evaluate, figure out what it’s worth, and then be patient enough to pay a reasonable price for it and then build a diverse portfolio of, say, 25-30 stocks, you’re going to be able to earn the equity premium, that is the premium return that you get for owning rather than lending and you can do it in a fashion that you can sleep at night. That’s the core of what we do.
Steven Halpern: You focus on stuff that you call underpriced and unloved, but I assume when you’re buying these you’re looking for some type of catalyst or a change in perception that will change these from being unloved to being in favor at some point.
Charlie Smith: Well, we’re not sure when a certain catalyst is going to come along. We know that if we can understand what a business is worth—given its return on equity and its consistent return on equity—and we can find a business that’s not too financially leveraged that can deliver that return on equity consistently and through a full cycle, because we all know that leverage can kill in a period where interest rates are spiking or credit qualities deteriorating.
We can find a business that’s able to deliver consistent levels of return on equity and then be patient enough to buy it at a reasonable price, that’s a combination that’s going to build investment success.
We’re not going to be successful every time. About a third of the time, for whatever reason, a name that we put in the portfolio doesn’t work, but if we’ve been disciplined enough to buy it at a reasonable price where, in cases where it does go wrong, we lose only maybe 15% or 20% of our money and then the other two-thirds of the portfolio is doubling or tripling over a five-year period.
That mix is going to produce a nice set of return for you.
Steven Halpern: Let’s look at a few holdings among your top holdings that would help highlight this long-term investment strategy. One of those is Kinder Morgan (KMI), which has been hurt by the downdraft in the entire energy sector. What’s the attraction here?
Charlie Smith: Well, Kinder, as you know, is the largest US natural gas pipeline. They’ve been building out not only their long haul but their gathering systems over the last couple years with significant amounts of investment and that really is helping build their cash flow.
The stock has been pounded down here in the last four or five months as a result of the fear that the big decline in oil and gas prices is going to wreck their results.
Remember, Kinder Morgan is a toll taker. They are dealing with very long-term contracts for the movement of natural gas and so they get, sort of, a fixed price for the gas that they move, so, their business is built on taking a fixed toll for movement of gas.
As you know, natural gas is gaining market share relative to coal, relative to crude oil, particularly in the powering of electric-generating plants. We’ve shut down a couple hundred coal-fired electric plants here—mostly in the Eastern US over the past few years—and so Kinder is gradually gaining a big share for very large volume contracts of natural gas delivered for electricity generation.
They’re in the process, right now, for example, of getting approval for a pipeline to move natural gas from Northern Pennsylvania into the New England area where energy prices have spiked considerably in each of the last couple of winters, so they are really in a good position in terms of taking a toll for movement of a fuel which is very much in demand.
The fear that we’ve seen as the stock has declined the last few months is really a function of the fact that they do have significant debt. Their balance sheet is quite leveraged, so the fear is—on the part of the marketplace—that they’re going to see a diminution in their revenue and have their fixed interest costs are going to be come problematic.
We don’t believe that their revenue is going to fall off to the point where their development levels are going to be a problem. The share is now yielding north of 6%. We think under $30, Kinder Morgan continues to be a pretty good investment.
Steven Halpern: Also among your top holdings is the long-standing blue chip AT&T (T). What qualifies this for the top holding in your portfolio?
Charlie Smith: Well, a reliable cash flow more than anything else at a very reasonable price. The company sells about six...six-and-a-half times operating cash flow. They’ve just made a couple of very large acquisitions. They bought a couple of good-sized cellular businesses in Mexico.
They’re integrating a video acquisition they just completed, so they have actually made some pretty serious investments the last few years that should be helping their cash flow; but, really, it’s a story of a very reliable revenue stream and reliable cash flow selling at a discount price with, obviously, a pretty decent dividend yield as well.
Steven Halpern: Now, finally, among your top holdings is a trio of leading industrial and manufacturing firms, Rockwell Automation (ROK), Honeywell (HON), and Boeing (BA). What’s the common theme here?
Charlie Smith: Well, the theme there really is worldwide air traffic and the steady increase in the numbers of people that are getting on airplanes around the world. Even in the depth of a recession back in 2008 and 2009, the real annual increase in worldwide air traffic was well above 5%-6%.
So the first thing that newly industrialized and newly wealthy economies—the people in those economies—want to do is get on airplanes and travel around.
And so, worldwide air traffic continues to grow, so the theme, really, is aerospace and the idea that companies like Boeing, Honeywell, which is obviously a big leader in avionics, and Rockwell—Parker-Hannifin (PH), another name that we own—all are going to benefit from, sort of, the tailwind of continuing increases in air traffic around the world.
Steven Halpern: Again, our guest is Charlie Smith of the Fort Pitt Capital Total Return Fund. Thank you for some fascinating insights today.
Charlie Smith: Good to be with you.