Open Season on Cash Cows
08/20/2009 9:50 am EST
Cindy L. Sweeting, manager of two flagship Templeton global funds, sees opportunities in profitable and heavily discounted multinationals.
Q. What's your view of the markets and the economy?
A. We've had a V-shaped snap back, with the markets up between 50% and 80%. From here on out, the market is going to start being a lot more selective. Earnings and cash flows are going to have to come through—not only from cost-cutting but from the start of a recovery on the top line.
We're probably going to be in a slower-growth environment than what we've experienced in the most recent economic cycle. There are still going to be head winds for the consumer. There is still going to be continuing financial sector de-leveraging. I'm more worried about deflationary tendencies than inflationary tendencies. What is the actual level of sustainable demand, and how much excess supply is there still around the world? And that's going to be a longer workout after this initial rebound from a very low base.
Q. Are the markets overvalued?
A. Some of the very deep cyclical areas—industrials, commodities, some of the consumer cyclicals—might have gotten a bit ahead of fundamentals. But there are certainly areas of the market where we are still finding good value.
Q. Which regions and industries around the world look most attractive?
A. Technology, telecommunications, media, and health care. We've got some 55% [of the Templeton Growth Fund's (TEPLX) portfolio] in those four areas, about a 25% overweight to the benchmark. The areas where we are not as optimistic over the longer term are financials—we think there were major excesses to be worked out and that after this initial rebound, profitability is going to be under pressure for some time. And we're also underweight materials.
Q. Many of your top holdings seem to be come from the mega-cap end of the stock universe.
A. That is an area of undervaluation. Small caps came from very undervalued levels at the end of the last decade and are now trading at a premium. The large, multinational, globally positioned companies have been de-rated fairly significantly over the last ten years. Ten years ago, people were willing to pay 45x earnings for Microsoft (Nasdaq: MSFT). The company has tripled its earnings over the last ten years and now it's trading at less than a market multiple and a 10% to 11% free cash flow yield.
Q. What's the catalyst that's going to reverse this trend?
A. Earnings and cash flow tend to be the catalysts for revaluations. Starting from low expectations, if those companies can produce the earnings and cash flow that we believe they can, that will be the catalyst.
Q. You seem to have a fair number of European companies among your top picks: Siemens (NYSE: SI; XETRA: SIE.DE), GlaxoSmithKline (NYSE: GSK; LSE: GSK.L), Sanofi-Aventis (NYSE: SNY; Paris: SAN.PA), Vodafone (NYSE: VOD; LSE: VOD.L).
A. We're not really buying Europe; we're buying European companies with exposure to many areas of the world that have been [undervalued] because they're domiciled in Europe and because Europe has this perception of being old, stodgy, [and] low growth.
Q. Is that the most promising region now?
A. We're about equal-weighted now between the US and Europe, very underweight Japan, and overweight Asia ex-Japan, primarily in Korea, Singapore, and Taiwan.
Q. So, you're not buying the Japan recovery story?
A. Structurally Japanese companies have some great difficulties. Other than some of the globally competitive exporters, most Japanese companies are not managed for shareholders; they're managed for employees, for management, for the banks, for the government, and return on equity and returns on capital are at a significant deficit to what companies in the same industries earn elsewhere.
Q. If your baseline forecast is for slower growth in the coming cycle, won't exporters like Taiwan Semiconductor Manufacturing (NYSE: TSM; TAIWAN: 2330.TW) and Samsung Electronics (Seoul: 005930.KS), which are among the top holdings of the Templeton World Fund (TEMWX), get hurt pretty badly?
A. Technology spending has actually been below trend over the last decade. There were such excesses in spending on technology during the 1990s before the tech bubble burst that it's taken a full decade to correct [them. During that time, tech companies] have cleaned up their balance sheets, consolidated, new managements have come in, [and] earnings yields have increased. When we're looking at valuations and what unit growth and pricing can be in some areas of technology, we're quite encouraged.
Q. Is there one particular metric that you're paying most attention to now in deciding which stocks to buy?
A. Free cash flow. That's the one common denominator between the areas we're overweight. That's money that can be allocated for the [company’s] growth or share buybacks or dividend increases, and if you can find managements that are good at allocating that free cash flow that's a good combination. Companies with good balance sheets and high free cash flow yield are undervalued by the market right now. A lot of the steadier cash-flow generators got left behind in the last market cycle.
Q. What company are you most excited about that most of us may not have heard of?
A. I can throw out a few: ICICI Bank (NYSE: IBN)—it's a bank that's very well positioned in India. Covidien (NYSE: COV) in the health care area: it was a spinout from Tyco International (NYSE: TYC) a number of years ago and is in some very good areas of the hospital and surgical supplies market; its cash flow had gone into the pot at Tyco and now it's available for shareholders.
A company that probably people have heard of but certainly doesn't get the valuation or the recognition for its quality is Accenture (NYSE: ACN), one of the primary [tech] outsourcing and consulting firms. And if you think about all the cutbacks that have taken place in the corporate world and the need to get higher productivity from employees, that’s going to help them.
Q. Thank you.