Romick joined FPA Crescent Fund in 1996. He is the portfolio manager of FPA Crescent Fund and the Contrarian Value Strategy. He is also a research analyst for FPA Capital Fund and the FPA Small/Mid-Cap Absolute Value Strategy and FPA New Income and the FPA Absolute Fixed Income Strategy. Prior to joining FPA Crescent Fund, Steven was Chairman of Crescent Management and a consulting security analyst for Kaplan, Nathan & Co.
Mr. Romick's portfolio consists of long and short equity positions and short term bonds and cash. He seeks value in all parts of a company's capital structure. In general, the manager invests in securities consensus does not want to own. The fund searches for stocks and convertible bonds reflecting low price-to-earnings ratios and trading at discounts vis-à-vis market value.
The Contrarian Value Strategy has an investment objective and philosophy. Its objective consists of providing, over the long-term, an equity-like return with less risk than the stock market. The main aspects of its philosophy are:
· Absolute value investors.
· Alignment of interests.
· Broad mandate.
· Long-term focus.
· Macroeconomic view.
· Downside protection / Risk minimization.
Here are his top conviction picks:
Aon Corp. (AON): Insurance brokerage and consulting services on related risk and human resources are Aon’s main area of operations throughout the world. The firm’s strong presence in more than 100 countries has helped it take the lead in this industry.
There has been a weak insurance pricing that affected the company’s results but this tendency is reverting and prices seem to get stability. This change has been boosted by young leaders wishing to see Aon defend and build its position.
In 2008, Aon acquired reinsurance broker Benfield which helped improve its intermediary value by regaining presence in the insurance market.
CVS Caremark Corp (CVS): CVS is the second largest pharmacy (by sales) and the second largest pharmacy benefits manager (PBM) in the U.S. The company has presence in 44 states through 7,000 drugstores, in the District of Columbia and Puerto Rico.
By gaining some recent new contracts and provided the health care reform takes place, the firm will substantially increase its growth.
The retail segment for CVS is a promising area of operations. The firm expects to maintain its strong performance in it going ahead with growth in both sales (2% 4%) and operating profit (7.5% 9%) in 2011 coupled with a 0.5% 2.5% rise in same-store sales. In the quarter, sales grew 2.3% leading to a 3.8% climb in retail revenues. Also, the company improved its selling, general and administrative expenses leverage. The operating margin was reported at 7.6% and the company achieved more than $700 million in annual purchasing synergies and overhead savings from its Retail-PBM combination. This will facilitate its future growth. Most importantly, during the quarter CVS opened 48 new clinics.
After certain stagnation, CVS improved its Pharmacy Services segment performance. During the quarter, the segment recorded an increase of 25.8% y/y in revenues, thus reaching $14.8 billion. This improvement in performance was encouraged by the contract with Aetna. As regards drugs, branded drugs are expected to go off-patent in 2012. The situation will be felt. Nevertheless, the company is confident about the progress in the PBM segment based on new businesses and strong client retention. By the end of the third quarter, the company completed more than 70% of 2012 renewals, which include AT&T, General Electric and a FEP Retail Contract worth $4 billion.
Why did Steven Romick invest in CVS? First, CVS has a strong balance sheet. It exited the quarter with cash and cash equivalents of $1.7 billion, up from $1.42 billion at the end of fiscal 2010. Moreover, the company generated over $1.5 billion in free cash flow during the quarter and $3.9 billion year-to-date and expects to generate free cash flow of $4.2 billion in 2011 with potential for further growth in 2012 and beyond. Second, the company is shareholder friendly. It repurchased 16.3 million shares for $579 million under the repurchase program. The board authorized a new share repurchase program for up to $4 billion. Subsequent to this authorization, CVS entered into a $1 billion accelerated share repurchase agreement under which it repurchased 25.7 million shares. As a result, during the quarter, it repurchased a total of 42.1 million shares at a cost of approximately $1.6 billion. Year to date, the company repurchased 69.5 million shares and spent approximately $2.5 billion. Third, there are motivating domestic demographic trends which would foster utilization rates for years to come as the population ages and thus paving the way for companies like CVS to grow and capture market share. CVS has taken steps to make prescription drugs affordable to consumers. These steps involve enabling consumers to obtain drugs through mail orders, avoid gaps in care while waiting for medication to arrive, and to enjoy of discounts on certain health care products.
Currently, the stock trades at $42.01 and the current price to earnings ratio is very near the average of 17. Dividend yield stands at just 1.5%. Over the past five years CVS earnings per share and cash flow per share have grown at average annual rates of 17% and 15%, respectively. Dividends have risen on average 18.5% over the same period. The payout ratio is still a very conservative 17% of net income, based upon estimated earnings for 2011. The company has been increasing the payout ratio gradually and it is expected to reach 25%. This leaves ample room for growth. EPS are expected to increase on average about 18% per year going forward with dividends increasing at more than 20% per year on average.
Last but not least the company holds the May 2012 call option with a strike price of $45 selling at a premium of $0.96 per share. This means that selling one contract will bring $96 ($0.96 x 100 shares) less the commission ($10) to net $86. The expiration date of the contract is May 18, 2012 so the return is 2.1% for just over four months or an annualized return of about 6%. The investor should be able to duplicate this process about three times per year to net approximately $258 on 100 shares. If added to dividend, the cash yield for holding the stock is about 7.5%.
Wal-Mart Stores Inc (WMT): Wal-Mart provides a broad assortment of quality merchandise and service in the retail segment which has gained customer’s trust. Besides, WMT has a significant presence in the international market in almost 14 countries and Puerto Rico. This presence has fostered growth and this is believed to continue in the years to come. Total sales at the international segment improved 1.3% reaching $32.4 billion.
Its policy of keeping low prices is led by Every Day Low Prices philosophy (EDLP). Under EDLP, the firm assures customers that prices will not change. The company has also made a move to acquire an app maker, Small Society. The purpose of this acquisition is to make customers scan products on their smart phones for the best prices. If someone walks into a Wal-Mart store, scans the product and finds a better price, then they could take this information with them to go to another store. Wal-Mart aims at changing the shopping experience for shoppers in store and online and compete with Amazon in online purchases. It is said that Amazon has already lost market share in favor of Wal-Mart.
Steven Romick saw in Wal-Mart and appealing candidate given the results reported as of January 5, 2012:
· Share Price: $59.42
· Expected 2013 EPS: $4.91
· Forward PE: 12.1
· Gross Profit: $106.56B
· Dividend Yield: 2.4%
Wal-Mart has a strong balance sheet. The company had cash and cash equivalents of $7,907 million in 2010 as against $7,275 million in 2009. Wal-Mart generated a positive free cash flow of $14.1 billion in 2010 as against $11.6 billion in 2009, up 21%. In Q3, Wal-Mart generated positive cash flow of $3.4 billion and it also returned $2.7 billion to shareholders in dividends and share repurchases.
Microsoft Corporation (MSFT): Microsoft Corporation is an American multinational corporation that develops, manufactures, licenses, and supports a wide range of products and services predominantly related to computing.
The rise of stock in the company's 1986 initial public offering made an estimated three billionaires and 12,000 millionaires from Microsoft employees.
MSFT is trying to enter the smartphone market since the total smartphone sales for this year will be nearly a half-billion, according to Gartner Group. This represents a great challenge since Microsoft would still have single-digit share of a market currently dominated by Apple's (AAPL) iOS and Google's (GOOG) Android. However, if MSFT charges the $15/handset it claims from Android phones, it will be over $500 million in revenues from the licenses alone. This has to be calculated jointly with the revenues coming from the launching of Windows 8. All together, combined with Xbox success could boost the stock from the current PE ratio of just 10. Better margins, plus a growth story, could thus bring Microsoft's PE close to that of Apple fairly quickly, which would mean a 50% gain.
Microsoft's partnership with Nokia will drive large market share gains for the Windows Phone platform and create the next $1 billion-plus annual revenue stream for the company. Besides, in 2011 MSFT acquired Skype Communication for $8.5 billion.
I think Steven Romick felt attracted to the stock because MSFT is a solid company that still has ample room for growth given its interest in expanding to different markets and industries.
Occidental Petroleum Corporation (OXY): Occidental Petroleum’s main area of business is the production and exploration of oil and natural gas and the manufacturing of chemicals and operations of midstream assets and pipelines and carbon dioxide processing plants. It is present in the United States, Latin America, and the Middle East.
In 2010, production was 753,000 barrels per day (74% liquids) and proven reserves stood at 3.36 billion barrel of oil equivalent (74% liquids).
Currently stock is trading at $91 a share and in general it is in a strong fiscal position that enables it to take advantage of distressed assets. Furthermore, the company is increasing production rates and adding reserves while other energy companies are unable to do so.
Why has it become a stock of interest for Steven Romick? Occidental has several advantages. First, the company is expanding into new technologies to increase domestic production. Second, OXY has been rated A in terms of balance sheet and has grown dividends´ yield by 17%. Third, Occidental has beaten consensus earnings in the last five consecutive quarters and given its forward PE of under 11 and its sales at less than 7 times operating cash flow, its stock is undervalued. Most importantly, the company is doing a great job in replacing and growing production. Credit Suisse predicts it will grow production at a 6% annual rate through 2015.
Last but not least, Occidental is engaged in the development of Iraqi oil fields. This may bring important long-term growth opportunities.