Billionaire Value Investor Michael Price's MFP Top Conviction Picks: JNS, LNCR, PFE, NLC, JCP
Price does not buy a stock unless he has strong reason to believe that the stock is offering value greater than what is indicated by its market price. He conducts thorough research in order to identify companies which have great potential and undervalued stocks.
Price was interested in stocks since his childhood. Price began his investment career as a research assistant at Mutual Series; a fund ran by renowned value investor Max Heine. He learned alot from Max and considers him as his mentor. After Max Heine’s death Price took over Mutual Series and later sold the firm to Franklin Templeton Investments. Even though he sold the fund, Price continued working for Franklin Templeton Investments until 1998, after which he became the Chairman of the Mutual Series fund. After leaving Templeton in 2001, Price started his own hedge fund, MFP Investors LLC.
Price uses an activist approach to investing. One of the strategies that Price has successfully employed is to buy stocks of companies going either through a bankruptcy process or undergoing a major restructuring effort. Such stocks are often beaten down in the market and trading at multiples not justified by their fundamentals. More often such companies are in desperate need of cash. Price usually injects cash into these companies, giving them enough time to breathe and then profits from their eventual turnaround. According to his methodology not every cheap stock qualifies as a ‘buy”. Instead, he goes through a very rigorous research process while searching for the right candidate to get into. He tries to gain in depth knowledge of the company’s prospects of overcoming its difficulties. He buys a stake in the company if his analysis leads him to believe that, barring its financial difficulties, the company possesses fundamental attributes which make it a good investment. Usually, buying a 5% stake in the common stock is large enough to enable him to influence the decisions of company’s management by recommending strategies which, if pursued, can potentially improve company’s performance metrics and eventually lead the stock to appreciate in price. More often his relatively large positions act as a catalyst and stock catches attention of street.
Here is a snapshot of his portfolio:
Janus Capital Group (JNS):
Janus Capital manages and sells mutual funds to both retail and institutional investors. The management and performance fees these funds generate become Janus' revenues, and these revenues have provided the company with a steady stream of cash flow over the years.
Janus has generated free cash flow of almost $250 million per year over the last decade, and there have been some bad years for the investment industry within that period (e.g. the tech crash, and the recession of 2008 and 2009). Despite this, JNS has a market cap of just $1.2 billion and has more cash than it has debt.
The problems causing Janus' stock price to drop appear to be temporary. First, Janus fell with the rest of the market, as correlations increased as macroeconomic issues appeared to take center stage.
But Janus generates fees for assets under management and performance. Therefore a drop in the stock market translates directly into lower revenues. But even in this environment, Janus still generated free cash flow of about $45 million in the 3rd quarter; annualized, this still translates into a yield of 15% under pretty poor market conditions. For sure, Michael Price saw this and was attracted to the stock.
Finally, Janus is also suffering some outflows as a result of poor short-term relative performance in some of its equity funds. Investors flock to the funds with the most impressive recent returns. Janus offers a range of funds, giving it the ability to grow the successful ones and shutdown the ones with poor market appeal. As such, these outflows due to under-performance are likely to be only temporary.
There is no question that the mutual fund industry has come under attack. Janus is a profitable company that allows investors to buy into this industry at what appears to be a very attractive price.
Lincare Holdings (LNCR):
Lincare Holdings Inc provides respiratory therapy services to patients with chronic obstructive pulmonary diseases such as emphysema, bronchitis and asthma. The company has approximately 750,000 customers in 48 states being serviced through 1,090 operating centers. LNCR is a free cash flow machine, generating an average of $247 million in free cash flow annually for the last decade. It is interesting to see that the company’s shares have traded down nearly 30% in recent months, such that its equity is now valued around $2 billion, for free cash flow yield of about 12.5%. LNCR faces several challenges in the coming years, including declining reimbursements from Medicare and increased price competition from other oxygen service providers. I think the company's size and position in the industry as the low-cost leader may not be enough to overcome the tougher regulatory environment.
Lincare is a leading provider of home-based oxygen and respiratory therapy services to patients nationwide. Its customers typically suffer from chronic obstructive pulmonary disease, which affects roughly 16 million people domestically. In the past, Lincare benefited from healthy reimbursement rates from Medicare and private insurance companies, and it was able to produce stellar returns on capital by leveraging its scale advantages. The company's position in the industry should continue to be strong; the $8 billion home-care market could grow as large as $12 billion during the next few years, driven by an aging population.
However, recent changes to the regulatory landscape are likely to stymie all industry players, including Lincare. Traditionally, Medicare-reimbursed companies provided oxygen to patients in their home on a monthly basis, for as long as the patient needed the service. But in 2009, the Centers for Medicare and Medicaid Services started capping payments after 36 months. In addition, CMS has cut payments by 9.5% for select durable medical equipment and is attempting to introduce competitive bidding for home services among all oxygen providers. While Lincare's national presence and scale advantages may give it a leg up in the bidding process compared with smaller providers, it will face an aggressive pricing environment as firms attempt to undercut one another to win business.
I believe these challenges were numerous enough to downgrade Lincare's narrow economic moat in 2009, and I continue to think the threatening regulatory environment surrounding the company justifies our high uncertainty rating. Lincare is attempting to diversify its revenue sources and payer mix by expanding into pediatric services and treatment of sleep-related disorders. The company may also be able to make attractive acquisitions by purchasing smaller regional providers that are also struggling with reimbursement cuts. However, I don't think these efforts will be enough to overcome the problems in its core business. I am not sure if Michael made a good buy in LNCR
Pfizer has a solid cash flow generation profile despite significant challenges to revenue line. I think The merger with Wyeth enables Pfizer to extract significant synergies, which should improve the company’s EPS profile during the important patent expiry period from 2011 onward. A business review is under way and is likely to result in increased shareholder returns supported by the company’s strong cash flow generation. However, it will take longer than initially thought. Nevertheless, Pfizer moves from a pure cost-cutting story to one which is supported by its pipeline. Pfizer’s shares currently trade at a P/E 2011E/12E of 8.5 and 8.4, at a significant discount to the US pharma sector at 10.1 and 10.9, respectively. The magnitude of the discount is not justified, and should gradually narrow.
Pfizer reported strong Q3 2011 revenues of USD 17.2 bn (up 7% YoY, up 1% in local currency (LC)), 5% above consensus expectations. Regionally, US revenues decreased 3% while international revenues grew 15% (4% in LC). Within Pharmaceuticals, most products beat expectations with Lipitor beating consensus by 12% and the Prevnar franchise meeting expectations. On a side note, Lipitor will lose patent protection in November 2011. Significantly lower-than-expected SG&A costs led to an operating profit of USD 7.27 bn (up 13% YoY), 13% above consensus. The resulting adjusted EPS of USD 0.62 (up 15% YoY) beat consensus of USD 0.56 by 11%, despite a higher-than-expected tax rate. The company raised its FY 2011 adjusted EPS guidance range from USD 2.16-2.26 to USD 2.24-2.29 (consensus currently expects USD 2.25) and confirmed its FY 2012 EPS guidance of USD 2.25-2.35. In addition, the company increased its FY 2011 share repurchase target to USD 7-9 bn (from USD 5-7 bn).
Nalco Holding (NLC):
NLC has been a big outperformer in Michael Price’s portfolio, returning near 20% in 2011. The company is involved in the basic materials sector, providing synthetic process services to water, paper, and energy industries. Nalco has announced its merger intention with Ecolab in July. According to the merger agreement, Nalco’s shares were priced at $38.80. Instantly the stock jumped to near $37, and it is trading near the acquisition price since. While MSD Capital sold out Nalco holdings while John Paulson was bullish on the stock, initiating a new purchase of 9.18 million shares, worth $355 million.
J.C Penney (JCP):
Despite persistent economic headwinds, J.C. Penney continues to demonstrate resilience. The retailer remains profitable, and is being cautious with its cash flow, especially given the economic recovery's stagnant and lethargic pace. I do not like very much the industry as a whole. Over the long run, I believe the competitive nature of department store retailing and its older store base will offer only thin returns on invested capital.
While its trendier peers draw a vibrant mix of more affluent, youthful, fashion-conscious shoppers, J.C. Penney's primary clientele almost reflexively skews toward older, less trendy, middle-market consumers with average to slightly below-average incomes. Its exposure to this demographic leaves J.C. Penney more vulnerable to the effects of macroeconomic headwinds than its higher-end retailing peers, given that this cross section of consumers has been hit hardest by the downturns in the employment and housing markets. While the market may overestimate the company's vulnerability at times, I only consider the retailer's shares when they are trading at a discount, rather than at a premium, to the average analyst fair value price.
I run a simple valuation model that implies 26 times January 2012 earnings and 18 times January 2013 earnings, 8 times enterprise value to EBITDA, and a cash flow yield of 5%.
I assumed growth of between 2%-3% during 10 years, and average operating margins of 5.8%, peaking around 2015 at 6.2%. Growth will come mostly from same-store sales; medium- and long-term same-store expansion from new stores will be in the low-single digits. Internet sales are included in comps, and the effect of the catalog exit is included in 2011.
Share buybacks should produce diluted shares of around 216 million at year's end, with a weighted average of around 220 million. Revenue is projected to be slightly negative, as flat comp-store sales are pulled down by store closures and the catalog exit.