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Bill Nygren's Buys and Sells in the Third Quarter

December 16, 2011 | About:
Holly LaFon

Holly LaFon

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Bill Nygren is portfolio manager at Oak Mark, a value investing money management firm. Nygren recently outlined the firm’s philosophy in a Bloomberg interview: “The thing we do differently than most other mutual fund companies is that our brand means something. Oak Mark is long-term value investing and every fund you get at Oak Mark is focused on what we think is going to be different five years from now, rather than trying to outguess people on next year.” Rather than ask what is going to happen next year, he asks how a company might perform in five years. Because of Nygren’s focus on valuations, he finds equities particularly attractive in the current market. He is looking for companies selling at relatively modest P/E ratios of 9 or 10 times earnings, with a reasonable pay out but that are not paying out the majority of their income. He says he has not seen valuations like today’s since the 1950s, yet investors seem indifferent to it.

In the third quarter, Nygren added Corning Inc. (GLW), and sold GlaxoSmithKline Plc ADS (GSK) and Walgreens Co. (WAG).

Corning Inc. (GLW)

Corning Incorporated creates leading-edge technologies for the fastest-growing markets of the world's economy. Corning Inc. has a market cap of $19.84 billion; its shares were traded at around $13.17 with a P/E ratio of 6.6 and P/S ratio of 3. The dividend yield of Corning Inc. stocks is 2.4%. Corning Inc. had an annual average earnings growth of 5.2% over the past 5 years.

Corning’s stock has not performed well, declining 33% over the last five years, yet has increased revenue at an annual rate of 5.6%. Free cash flow grew to unprecedented levels last year, increasing from $226 in 2008, to $1.2 billion in 2009, to $2.8 billion in 2010. Revenues also reached their second-highest company high in 2010. The results were due to improved year-over-year performance in each of its segments. All but one of its segments saw double-digit sales increases. Sales at Corning are dependent on a relatively low number of sources. Just 10 customers accounted for 55% of its 2010 sales.

The company plans to use its improved financial position to make strategic investments to improve its competitive position. Among its growth plans for 2010 were a number of expansions to global operations, a new life sciences manufacturing and distribution facility in China, and acquisition of a life sciences business in France.

Nygren explained why he chose this as his only new holding in his third-quarter shareholder letter:The reason your iPhone screen doesn’t break as easily as the first ones did is that they now are made with Corning’s Gorilla Glass. In 2000, when Corning was the main supplier for new fiber-optic networks, the company had EPS of $1.23 and its stock reached a high of $113. Today, fiber optics has taken a backseat to glass for displays. Corning earned over $2 per share last year and should come close to that level again this year. Despite a more diversified business mix, the stock now trades at less than seven times earnings and at less than book value. We believe that price represents an attractive entry point for purchasing a worldwide leader in glass technology.”

GlaxoSmithKline (GSK)

GlaxoSmithKline is one of the world's research based pharmaceutical and healthcare companies and is committed to improving the quality of human life by enabling people to do more, feel better and live longer. Glaxosmithkline Plc Ads has a market cap of $113.95 billion; its shares were traded at around $45.19 with a P/E ratio of 12.3 and P/S ratio of 2.5. The dividend yield of Glaxosmithkline Plc Ads stocks is 4.9%. Glaxosmithkline Plc Ads had an annual average earnings growth of 3.2% over the past 10 years.

Nygren closed out his position in GSK in the third quarter. He has held shares since before the first quarter of 2009. His last trade was a sell of 35,000 shares at an average price of $39 per share. He sold the remaining 1,565,000 shares for about $42.40 per share.

Over the last five years, GSK’s stock declined about 14%, and it has a P/E in the higher range of what Nygren mentioned he looked for, at 22.28. The company also suffered from 2% lower sales year over year due to a 472 pound sales loss of pandemic products Avandia and Valtrex. It is looking at ways to curb costs, improve sales and reduced re-investment requirements, which will allow it to drive operational leverage and improve operating margins in 2012. However, the effectiveness of the measures will depend on the strength of its pipeline and the launch of new products.

Another thing Nygren looks for is a decent dividend, but not one that takes too much of the company’s profits to pay. In the second quarter, GSK increased its dividend 7%, to 16 pence per share. In the first half of the year, the company repurchased 0.9 billion pounds of its own shares, and expected to repurchase a total of 1-2 billion pounds for the full year. For the full year of 2010, the company paid roughly 50% of its free cash flow in dividends, probably too high a figure for Nygren.

A new overhang appeared for GSK stock in the form of an SEC accusation that a subsidiary of the company and its former chairman and CEO defrauded shareholders by buying back stock at undervalued prices. The subsidiary denies any wrongdoing, according to Dow Jones Newswires.

Walgreens (WAG)

Walgreen Co. is a national retail pharmacy chain and considered the leader in innovative drugstore retailing. Walgreen Co. has a market cap of $28.98 billion; its shares were traded at around $34.11 with a P/E ratio of 12.5 and P/S ratio of 0.4. The dividend yield of Walgreen Co. stocks is 2.7%. Walgreen Co. had an annual average earnings growth of 11.7% over the past 10 years. GuruFocus rated Walgreen Co. the business predictability rank of 4.5-star.

Walgreens stock has lost 23% over the past five years. Revenue grew at an annual rate of 10% over that time, and free cash flow increased 9.3%. For the quarter ended May 31, the company reported $1 billion in free cash flow, of which it returned $535 million to shareholders through repurchases and dividends. Sales that quarter increased 6.8% from the same quarter last year.

The company is also putting considerable effort and money into expansion. On June 3, it bought drugstore.com Inc., providing it access to more than 3 million online customers. It opened or acquired 41 new drugstores, compared to 361 in the same quarter 2010.

A major shift also took place for the company that quarter, as it did not renew its contract with pharmacy benefit manager Express Scripts Inc. (ESRX), effective Jan. 1, 2012. This is causing several major healthcare providers to direct their customers to use other pharmacies to ensure they still have coverage for their prescriptions, according to a Dow Jones Newswires Report, although there is dispute about how much it will affect Walgreens’ business.

“We believe the long-term ramifications of accepting Express Scripts’ proposal with below market rates and minimal predictability for the services we provide would have been much worse than any short-term impact to our earnings,” said Walgreens Executive Vice President and Chief Financial Officer Wade Miquelon when the company announced the news in June. “All parties involved in providing health care must work together to bring down costs. In a world where cost effectiveness and access to health care is so important, any time an intermediary continues to disproportionately grow its profit per prescription at the expense of the provider delivering the service, the relationship is out of balance.”

To see Bill Nygren's complete portfolio, click here.



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