Value Expert's "Beaten Down" Bets

08/26/2016 10:00 am EST

Focus: STOCKS

Peter Mantas

CIO, Logos LP

Peter Mantas, chief investment officer at Logos LP has a value-oriented philosophy often focused on out-of-favor investment ideas. Here, he discusses his strategy, his emphasis on "catalysts", and a trio of stocks he considered undervalued in the current market.

Steve Halpern:  Our special guest today is Peter Mantas, a leading value investor and manager at Logos LP.  How are you doing today Peter?

Peter Mantas:  I'm good.  How are you?

Steve Halpern:  Very good.  Thanks for taking the time.  Could you tell our listeners a little about your background and a little about the underlying operations at Logos LP?

Peter Mantas:  Sure.  I am chief investment officer of a partnership, and my business partner and I are both trained lawyers with some management experience.

And it is safe to say we essentially developed a strategy somewhat after the "Munger School of Economics", which really takes a different approach to value investing, and looks at various other catalysts including quality and opportunity.  

Logos LP takes that model where we looked for investments that have the opportunity to compound very high rates for very long periods of time and we use those catalysts and opportunities to really dive deep into the equities that we find interesting.  

Steve Halpern:  Now you mentioned Munger; I assume you're referring to the partner of Warren Buffet, also a well-known value expert.  

Peter Mantas:  Exactly.

Steve Halpern:  Now, you tend to focus on stocks where you expect some of growth catalyst.  Can you expand on this aspect of your strategy?

Peter Mantas:  Sure.  A very important part of value investing, for us, is identifying specific characteristics or catalysts.

So this can be a high quality company with predictable earnings that, for whatever reason, has been beaten down due to macro-economic pressures or specific market variables and that can create large upside returns.  

It can also mean a company in the process of creating a large moat through our own analysis that, for whatever reason, has also been beaten down or is in a transition period.

And that can create large growth opportunities going forward, so these are the kinds of things on top of the basic financial metrics that we use when intensifying companies for our current investment.

Steve Halpern:  Now you also note that you also look towards stocks that are considered disliked by the overall market.  Could you touch on some of these factors, and maybe explain how the contrarian role takes a part in your strategy?

Peter Mantas:  Sure.  Part of the problem with value investing, and utilizing a quality approach is that a large amount of equities in that realm will have a premium to them because of the high returns on investment capital that are associated.

So one of the things that we tend to look at are companies that can have those metrics but for whatever reason are significantly beaten down and I will touch upon them of my pick moving forward, and this can be for a variety of reasons.  

The more beaten down they are, the more interested we start to get into those names.  It is important to note that the difficulty is getting stuck in a value trap.

So what we try to do -- on top of things that are unloved, or contrarian, or it can be an equity stub -- there has to be some level of safety in our view and that will generally pertain to the underlying operations, the quality of management, the historic returns on investment capital and the markets that they're operating going forward.

Steve Halpern:  One stock that meets the criteria that you outlined is Agrium (AGU) – which trades on the New York and Toronto exchanges -- which is agricultural play.  Could you share your thoughts on this company?

Peter Mantas:  Sure.  Agrium is a large, most people know it as a large fertilizer company, and it makes about 8% of its revenue from potash (which is down 40%), and 38% in nitrogen – which it near the peak cycle because of the low natural gas cost.  

The real opportunity here is the company is down I think 24% over the last year, almost double digits year-to-date and the key earnings driver going forward is going to be the retail side which includes Precision Ag, Crop Production, and specific crop nutrients.

And roughly 17% of the market in the United States, with 40% in co-ops and the growth in that area is very high, double digits, with the stability of earnings is very strong.

And so if you're calculating roughly by our estimates 2% to 3% on the nitrogen side, 1% to 2% growth in the potash side, and roughly mid to high in their retail, we believe the company has significant upside going into 2020.  Looking at almost roughly 10% to 15% a year.  

We believe that it's an immense opportunity.  However, we would also note that we don't believe it's yet close to a bottom, so I would be careful when looking at this stock.  I would be more interested closer to the $107 to $105 price point on the Toronto exchange.

Steve Halpern:  You also point to Enghouse Systems (Toronto: TSL), which trades on their Toronto exchange.  What is the story of this company?

Peter Mantas:  Enghouse is a global provider of communication systems, routing, networking, transportation management, asset management.  

Their primary markets are call centers, ambulance fleets, things of that nature, and they have very, very wide moat because of their one of the biggest players in the market.  

What's great about this business is that they have very high return on investment capital, very high free cash flow to sales percentage, over 15% on my last view, very high growth margins over 50%.

But what's more remarkable is that they have no debt and they are an acquisition-based tech conglomerate -- with similar consolation software.

This company is down roughly 30% for the year, and mainly because a large percentage of their revenue is in the UK, and since Brexit, this company has really dived.  

Nothing has changed fundamentally with respect to business earnings and growth is still relatively the same, and the contact communications market is growing at roughly 10% a year and should be as predicted hit $9.7 billion by 2020, so we believe there is a lot of market share opportunity.  

They are very smart when they make their acquisitions and that level of return on capital with virtually no debt clearly creates an opportunity where you have the perfect combination of a quality company in a very specific market, which they are very good at, but for whatever reason -- well we know this reason -- but because of various other variables, is down significantly on the year.

Steve Halpern:  Now finally, you see value at another technology firm called Luxoft (LXFT), a company that probably most of our listeners have never heard of.  What is this situation about?

Peter Mantas:  Luxoft is based out of Zug, Switzerland, a remote city in Switzerland.  It was started by two Russian founders and they do very, very, very high end IT development and consulting services.  

Their clients are major, major banks such as the backend of a particular large investment bank, or large retail banks.  They have clients that are in telecom industry, and oil and gas.  

They are similar to Enghouse in the sense that their skills are highly specialized.  They have a number of Ph.D.'s working for them, so it's a very, very technical group and what's great about these guys is similar to Enghouse is they virtually have no debt.  They have very high returns on capital.  Growth is very high, over 20%.  

It has been unfairly beaten on evaluation because of that European exposure and also the earnings aren't as streamlined as Enghouse, because they're in the more development services space or consulting.  They have a little bit more risk similar to an Accenture (ACN) or a CGI Group (GIB), but we believe there is a tremendous opportunity.

In fact, I would argue that Luxoft is slightly more undervalued than Enghouse due to the hit that it sustained because of the specialty and focus they're in and the incredible growth opportunities in those particular markets.  

There is very little downside to risk due to the high return on capital, the extreme focus they have on those markets, and the no debt that they have.

Steve Halpern:  Again, our guest is Peter Mantas of Logos LP.  It's always fascinating to hear your thoughts.  Thank you so much for your time today.

By Peter Mantas, Chief Investment Officer at Logos LP

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