In his third quarter Value Fund commentary, Weitz was upbeat about the prospects the volatile market was presenting: “The third calendar quarter was an active one for the Fund. Unprecedented volatility during August and portions of September presented long-term business owners with some attractive opportunities. Many pundits have noted (some with frustration) the increased correlation amongst stocks, with a seeming lack of regard in some instances for differences in quality, competitive positioning and future growth. These are the kind of environments where we as stock pickers get excited.”
Weitz tends to invest in companies that offer services rather than tangible products, as he believes they are less vulnerable to pricing pressure and more in control of what happens to them.
Weitz made another bullish comment in the October issue of Barron’s: “
Weitz’s largest new buys in the third quarter are Valeant Pharmaceuticals International (VRX), Hewlett-Packard Co. (HPQ), Wal Disney Co. (DIS), SPDR KBW Bank ETF (KBE).
Valeant Pharmaceuticals International (VRX)
Valeant describes itself as a multinational, specialty pharmaceutical company that develops, manufactures and markets a broad range of pharmaceutical products. Its specialty pharmaceutical and over-the-counter products are marketed under brand names and are sold in the U.S., Canada, Australia and New Zealand, where it focuses most of its efforts on products in the dermatology and neurology therapeutic classes. It also have branded generic and OTC operations in Europe and Latin America which focus on pharmaceutical products that are bioequivalent to original products and are marketed under company brand names.
Valeant was founded in 1960 but merged with Canada’s Biovail corporation in 2010 and retained the name, as well as Valeant’s CEO, J. Michael Pearson. After the merge, the company moved to Biovail’s headquarters in Ontario, Canada.
Valeant differs from other drug companies in that it has growth mostly through acquisitions. The company still has a pipeline of early and late-stage drug candidates, but also plans to expand its pipeline by adding new compounds and product acquisitions through company and product acquisitions. It has only four dermatology drugs in its development pipeline— acquired through acquisitions— and five in its neurology development pipeline.
The fourth quarter of 2010 was the newly merged companies’ first full quarter of combined financial results. In the third quarter of 2011, its total revenue was $600.6 million, compared to $208.3 million the third quarter of 2010. Product sales were $570.4 million, compared to $201.4 million. Results in the third quarter 2010 reflect only Biovail results as the quarter predates the merger.
The company can also circumvent much of the trouble other drug companies are facing from generics with its own generics business. “Branded generics are an attractive business for Valeant with low research and development costs and sustainable sales that do not face the patent expiry of traditional pharmaceutical compounds,” the company says.
Weitz commented on his investment in Valeant in his third quarter Value Fund commentary: “Valeant Pharmaceuticals is a multinational specialty pharmaceutical company with operations throughout North America, Central & Eastern Europe and Latin America. Valeant brings a unique, financially-driven approach to the business of manufacturing and selling drugs. The company's lack of product concentration, U.S. government reimbursement exposure and patent risk are key pillars in our investment thesis. CEO Michael Pearson is a talented owner/operator who we trust to do intelligent things with the ample excess cash flow Valeant generates.”
Weitz bought 1,035,080 shares of Valeant in the third quarter at about $45.93 per share. The stock price is up 61.5% over the last 12 months.
Hewlett-Packard Co. (HPQ)
Hewlett Packard is one of the leading global providers of computing and imaging solutions and services for business and home. Its major businesses include Imaging and Printing Systems, Computing Systems and Information Technology Services.
For fiscal 2010, HP’s total net revenue increased 10%; U.S. net revenue increased 7.8%, while revenues from outside the U.S. increased 11.3%. Though many investors have worried about the onset of declining PC sales as new technology arrives, the Personal Systems Group segment was the largest contributor to the company’s revenue growth. Desktop PC revenue increased 7.4% from 2009. On October 27, HP announced it had nixed its plan to sell its PC business.
The company’s stock has fallen 36.4% year to date to $26.76 on Thursday, with a 52-week range of $21.50-49.39. As a leader in the computer industry, HP has historically been a highly profitable company. It has had 10-year revenue growth of 10.6%, reaching a record of $126 billion in 2010, and free cash flow growth of 19.4%. Net income also reached a record of $8.7 billion, up from $8.3 billion in 2009.
Weitz commented on Hewlett-Packard in his third-quarter Value Fund letter, “Lastly, we initiated a position in Hewlett-Packard during the final week of the third quarter. Following a string of controversial decisions and poor execution by its former management, investor sentiment toward the company reached all-time lows. We acknowledge HP will undoubtedly face challenges in the near-term as it reformulates its strategy, integrates Autonomy and rebuilds customer trust under new CEO Meg Whitman. Nonetheless, we believe HP's portfolio includes a number of very attractive and entrenched businesses worth far more than the less than 5x trailing earnings we paid to acquire them.”
Weitz bought 810,558 shares in the third quarter at an about $29.46 per share.
Walt Disney Company (DIS)
Walt Disney Company owns 100% of Disney Enterprises, Inc. which, together with its subsidiaries, is a diversified worldwide entertainment company with operations in five business segments: Media Networks, Studio Entertainment, Theme Parks and Resorts, Consumer Products and Internet and Direct Marketing.
Walt Disney announces its fourth-quarter financial results on Thursday. For the third quarter, its diluted EPS increased 15% year over year to $0.77, compared to $0.67. Its free cash flow declined 20% year over year. Disney has a broad array of brands that it believes positions it well through the current economic ups and downs, including media networks including ESPN, parks, resorts and consumer products.
The largest drag on operating income for the quarter was its studio entertainment, which fell 60%, primarily due to a decrease in worldwide theatrical results. Its largest grower was consumer products, which increased 32%, due primarily to an increase at Merchandise Licensing, particularly for “Cars” merchandise and Marvel properties.
Though Disney had a decrease in many financial measurements from 2008 to 2009, things improved from 2009 to 2010. Revenue increased from $39.2 billion to $38 billion, net income increased from $3.3 billion to $4 billion and free cash flow increased from $3.3 billion to $4.5 billion.
In November, Disney and YouTube are expected to announce a partnership worth $10 to $15 million, the New York Times reported. The agreement is that Disney would produce an original video series that it would air exclusively on a new co-branded channel on both Disney’s website and Youtube.
Weitz commented on Disney in his third-quarter Value Fund commentary: “The Walt Disney Co. made a return appearance to the Fund during the quarter. The quality of Disney's brand(s), media networks and park and resort assets are, of course, a poorly kept secret. This has created a dearth of opportunities over time for value-conscious owners to own shares despite our admiration for the company and its culture. Fears of a retreating consumer and a weakening in global advertising demand gave us what we believe was an attractive entry point for a world-class asset during the third quarter. While not yet a full position, we will continue to look for opportunities to add to our stake on any future weakness.”
Weitz bought 444,100 shares of Disney in the third quarter for about $34.96 per share. Disney’s stock price has declined 7.65% year to date.
SPDR KBW Bank ETF
The SPDR S&P Bank ETF says it “seeks to closely match the returns and characteristics of the S&P Banks Select Industry Index (SPSIBK). Our approach is designed to provide portfolios with low portfolio turnover, accurate tracking and lower costs.” Year to date, the fund is down 31.54%, and down 18.7% for the last five years.
The ETF contains is composed of 69.2% regional banks, 9.88% thrifts & mortgage finance, 8.33% diversified banks, 7.4% other diversified financial services and 5.34% asset management & custody banks. Its largest holdings are East West Bancorp Inc. (EWBC), Fifth Third Bancorp (FITB), Keycorp New (KEY), Comerica Inc. (CMA) and U.S. Bancorp Del (USB).
The dividend yield of the ETF is 1.36%, and it has a P/E of 11.84 and P/B of 0.81. Weitz bought just 100,000 shares of SPDR KBW Bank ETF at about $20.48 per share.
In his third quarter commentary, Weitz said, “The U.S. financial system is much stronger today than it was 3-4 years ago. The slow motion train wreck in Europe is widely anticipated and should not create the same kind of liquidity crisis as the failures of Lehman Brothers and AIG.”
View more of Wallace Weitz’s portfolio here.