First Pacific Advisors (FPA) is an investment management firm located in Los Angeles, California. There are numerous funds associated with the firm, each utilizing a unique strategy to preserve and expand capital, as referenced in another article: http://www.gurufocus.com/news/130280/first-pacific-advisors-and-robert-rodriguezs-top-stocks-rdc-esv-rose-arw-avt. One fund in particular, the FPA Crescent Fund was found in 1993, and led by Steven Romick. Steven Romick earned his BS in education from Northwestern University, and is a holder of the CFA charter.
The stated objective of the Crescent fund is “to provide, over the long-term, an equity-like return with less risk then the stock market”. FPA Crescent intends to preserve capital via downside protection from hedging, and to minimize volatility at all times. Utilizing a contrarian approach to select investment opportunities, FPA Crescent seeks equities with low P/E ratios, a strong market share, exceptional leadership, and with large returns on capital that for one reason or another, fell out of favor with mainstream analysts. Equities are further screened by seeking industrial underperformers, and once the list of potential investments is constructed, contact is established with company management, their suppliers, and clientele in order to render the macroscopic view of the company.
In addition to the typical fundamental analysis conducted, an intensive analysis of capital structure is stressed in order diversify the portfolio. FPA Crescent looks for corporate bonds and preferred stock in companies with the aforementioned criteria that also yields significantly larger returns then government securities with minimized credit risk. FPA Crescent believes that in conjunction with equities, fixed income securities provides diversification, a stream of income, and lowers the overall volatility of the portfolio.
As a result of their contrarian strategies, since inception, they have an annualized return of 11.3% vs. the benchmark S&P 500’s 8.3%. In addition, FPA Crescent has a cumulative return total of 201.4%, vs. the benchmark’s cumulative return of 164.1% for the same time period. In terms of risk, the standard deviation of the fund is 10.62%, compared to the benchmark’s 15.39%.
Looking forward however, according to Romick’s “Wait and Hope” letter (Source 1), Steven Romick presents a rather negative view about future market conditions. The first point problem alludes to the fact that “…we depend on government data, but it’s not easy to have confidence in their numbers”, referring to the questionable credibility of government released statements. Steven Romick firmly believes that inflation is higher then what is reported, and makes note of the deteriorating situation with government programs such as Social Security that seemingly will go bankrupt. Steven Romick sees programs such as Social Security, public pensions, and Medicaid as indicative of the growing debt problem.
Steven Romick presents a grim image of the US debt situation, as total government debt makes up 100% of GDP, with 43% debt maturing in March 2013. He mentions that 50% of debt is owned by foreign holders, yet, given a small increase in the cost of debt, the interest expenditure of the nation will balloon. Furthermore, he reasons that it will be significantly harder in the near future to find interested investors in American debt due to the deteriorating value of the dollar.
With his disbelief of both the US debt situation, and of government statements, FPA Crescent has positioned its overall portfolio to be “mindful of the over-priced nature of small-cap stocks, the prospect of higher inflation, and the potential for better growth oversea”. As such, they have concentrated their investments into high quality companies with large exposure to foreign revenue. In addition, Romick specifically noted their investments into the energy sector due to the somewhat miscorrelation between inflation and earnings in that sector. To capitalize upon inflation, FPA Crescent has invested in other opportunities that will benefit from inflation, such as funding of REITS investing in farmlands and subprime loans.
As demonstrated in the following table, most of the portfolio is allocated to long positions in equities. For the most part, the composite portfolio remained generally the same, with the largest change originating from a decline in the corporate fixed income segment by approximately 4.10%. This change was counterbalanced by an increase in US government bonds by 3.30%.
Overall Portfolio Composition | Q1 2011 | Q4 2010 | % Change |
Common Stocks, Long | 60.00% | 57.70% | 2.30% |
Common Stocks, Short | 3.60% | 3.70% | -0.10% |
Corporate Fixed Income | 8.30% | 12.40% | -4.10% |
Mortgage Backed | 1.70% | 2.30% | -0.60% |
US Government Bonds | 14.40% | 11.10% | 3.30% |
Liquidity | 11.40% | 12.10% | -0.70% |
Other | 0.70% | 0.70% | 0.00% |
As shown in the following charts, the following five equities are the top holdings of FPA Crescent, comprising 21.92% of the composite portfolio. In terms of the composite portfolio, FPA Crescent has $4.9 billion invested into 125 positions, and $1.12 billion in cash and their equivalents. The average P/E ratio of the entire fund is 15.2, vs. the S&P 500’s 16.7.
Top Five Holdings for Q1 | Symbol | Composition | Shares | Value |
Aon | AON | 4.89% | 4,530,000 | 239,908,800 |
Ensco | ESV | 4.82% | 4,085,000 | 236,276,400 |
CVS Caremark Corporation | CVS | 4.40% | 6,292,000 | 215,941,440 |
Covidien | COV | 4.10% | 3,875,000 | 201,267,500 |
Occidental Petroleum | OXY | 3.71% | 1,740,000 | 181,812,600 |
Total Value of Equity Portfolio | 4,904,762,301 |
Aon Corporation (AON, Financial)
“Our largest position is an insurance broker whose revenues go up to commensurate with the insured value of the buildings underwritten, but isn’t dependent on inflation”.
The Aon Corporation provides services ranging from human resource consulting, insurance, risk management, to outsourcing consultancy. Their shares currently trade at $52.44, with a market capitalization of $17.32 billion. The average cost of Aon shares in the portfolio is estimated at $39.56, a potential 32.5% capital gain. The overall holdings of Aon Corporation increased by 3.3%, which in turn, elevated Aon’s position to become the largest holding of the equity portfolio totaling at 4.89%.
Aon has a P/E ratio of 20.79, a P/B ratio of 2.14, and a P/S ratio of 2.06. Their earnings for the year were $2.52 per share, with a dividend yield of 1.15%. Aon reported a profit margin of 8.92% on revenues totaling $8.5 billon. The Aon Corporation historically has grown its book value and free cash flow by 7.4% and 4.5% respectively.
Recent developments at the Aon Corporation include the naming of Kristi Savacool and Baljit Dail as co-chief executive officers. In addition, Aon announced plans to offer a corporate health care exchange to employers throughout the country.
GuruFocus rated AON with the business predictability rank of 1 star.
Ensco PLC (ESV, Financial)
Ensco is an offshore contract drilling company operating through four primary segments: Deepwater, Asia Pacific, Europe and Africa, and North / South America. Their shares currently trade at $53.73, with a market capitalization of $7.73 billion. FPA Crescent paid an average of $43.94 per share, representing a potential 22.2% capital gain. Ensco is the second largest holding of the portfolio, comprising 4.82% of the overall equity portfolio.
Ensco has a P/E ratio of 17.14, a P/B ratio of 1.28, and a P/S ratio of 4.53. Ensco reported earnings of $3.16 for their fiscal year, and maintained its dividend yield at 2.59%. Ensco’s revenue totaled in at $1.696 billion, with their net income at $548 million, yielding a 32.33% margin. For the last 10 years, Ensco has grown its revenues and earnings by 15.1% and 33% annually.
Credit Suisse rated Ensco with the “outperform” rating, while Duncan-Williams reiterated its “Strong-buy” rating on Ensco. Ensco is currently in a legal dispute with the US Government regarding permits for deepwater drilling in the Gulf of Mexico.
GuruFocus rated ESV with the business predictability rank of 4.5 stars.
CVS Caremark Corporation (CVS, Financial)
“The population of older people is growing more quickly then the younger age groups, and this accelerated aging of the population will drive pharmacy utilization”
CVS Caremark Corporation is a pharmacy chain operating throughout the United States, with over 7,000 storefronts in operation. CVS currently trades at $38.44, with a market capitalization of $52.08 billion. An average cost of $31.70 is estimated for CVS in Crescent’s portfolio, yielding a 21.6% potential capital gain. In addition, CVS’s holdings increased by 40% from Q4 2010 to Q1 2011. CVS is the third largest holding of the portfolio, making up 4.40% of the equity portfolio. Steven Romick mentioned in his letter several times of his optimism of just-in-time pharmacies such as CVS and Walgreens for a multitude of reasons ranging from geographic concentration, to an aging population.
CVS has a P/E ratio of 15.64, a P/S ratio of .54, and a P/B ratio of 1.39. Their profit margin for the year was 3.57% on revenues of $96 billion. This translated to earnings of $2.47 per share, with a dividend yield of 1.29%. CVS has grown its earnings and revenues annually for the last 10 years by 17.4% and 11.5% respectively.
CVS has implemented testing of a new system to increase the efficiency of their operations and level of service to their consumers via a real-time electronic prior authorization system. CVS revealed a SEC inquiry into company security transactions and CVS’s pharmacy benefits management unit.
GuruFocus rated CVS with the business predictability rank of 4.5 stars.
Covidien LTD (COV, Financial)
The Covidien Company develops, manufacturers, and sells healthcare products in the medical devices, pharmaceutical and medical supplies industry. Covidien trades at $56.25, with a market capitalization of $27.88 billion. The average cost of acquisition of Covidien is $43.55, a potential 29.1% capital gain.
Covidien has a P/E ratio of 17.21, a P/B ratio of 3.08 and a P/S ratio of 2.65. Sales for the year totaled in at $10.4 billion, rendering a 14.99% margin. Covidien’s most recent earnings were $3.26, with a dividend yield at 1.43%. In the last year, revenues and earnings grew by 2.4% and 45.5% respectively.
Morgan Stanley analysts placed an “overweight” rating on Covidien, with a price target of $63, a 12% capital gain. Jose Almeida is slated to become company CEO on July 1st, when the current CEO retires. Looking forward, he stated his confidence in growth of sales for Covidien due to the overall increase in bariatric and thoracic procedures in the country.
Occidental Petroleum (OXY, Financial)
Occidental Petroleum is an oil & gas corporation operating through four segments: oil & gas, chemical, midstream, and marketing. Their shares currently trade at $102.08 with a market capitalization of $82.74 billion. The cost of acquisition per share is estimated at $80.94, yielding a potential capital gain of 26.1%. Between Q4 2010 and Q1 2011, Steven Romick increased his holdings of OXY by 5.77%.
Occidental Petroleum has a P/E ratio of 16.86, a P/B ratio of 2.75, and a P/S ratio of 4.29. Occidental reported earnings at $6.02 for the year, with a dividend yield at 1.81%. Their revenue totaled in at $19 billion, with a net income at $4.3 billion, yielding a margin of 22.78%. Growth at OXY has been largely positive, with revenue and earnings growing 8% and 18.3% annually for the last 10 years.
In Columbia, a deal was reached with unionized workers to avoid a possible strike. The production in their oil fields in Oman increased 18% in Q1. Argus analysts placed a “buy” rating on Occidental, with a price target of $121, an 18.53% capital gain from current prices.
GuruFocus rated OXY with the business predictability rank of 1 star.
For more information regarding Steven Romick and The FPA Crescent Fund, please visit:
http://www.gurufocus.com/ListGuru.php?GuruName=Steven+Romick
Sources:
1. http://www.fpafunds.com/news_05052011_valueinvesting.pdf
2. http://www.fpafunds.com/downloads/crescent/March%2031,%202011.pdf
