Hotchkis and Wiley is an investment manager set up in 1980 that has a disciplined investment approach. The firm finds companies whose stock is below market price but with potential for appreciation, and companies with tangible assets and sustainable cash flow too.
Hotchkis and Wiley applies several value equity approaches, the Large Cap Diversified Value Strategy and the Large Cap Fundamental Value Strategy, which are similar regarding their goals but differ in their market-cap ranges, number of portfolio holdings and income requirements. Their goal is to invest in large-cap companies with sustainable cash flows and strong balance sheets undervalued stock vis-à-vis their tangible assets and long-term earnings power. The construction of the portfolio under these two approaches is based on a severe and independent research and bottom-up security selection. While the Large Cap Diversified Value Strategy was developed 10 years ago, the Large Cap Fundamental Value Strategy has been put into practice for almost 30 years.
The goal of both strategies is to exploit market mispricings by applying a consistent investment process centered on a balanced assessment of return and risk.
Another investment strategy the firm applies is the Mid-Cap Value Strategy, they have used for 14 years. As opposed to the above two, this strategy focuses on mid-cap companies rather than on large-cap stock. However, these mid-cap companies should also have strong cash flow and balance sheets with undervalued stock in relation to their tangible assets and earnings power. Hotchkis and Wiley also apply the Small Cap Value Strategy, which dates back more than 25 years. This strategy is characterized by focusing, as its name suggests, in undervalued, small-cap stocks with strong cash flows and balance sheets.
The goal of these last two strategies is to exploit market mispricings that result from Wall Street’s limited coverage of mid-cap stocks.
The firm may also apply the Value Opportunities Strategy. This strategy invests in a mix of undervalued securities and improves the firm's quick reaction when they identify undervalued stock. The portfolio is primarily made up of equities. However, the company may also invest in debt, convertible, preferred and options.
On the other hand, the firm also holds income strategies, namely, the Capital Income Strategy and the High-Yield Strategy. The Capital Income Strategy, a newly developed approach, improves the ability to carry out research in equity and high-yield securities and enables Hotchkis and Wiley to build a portfolio based on high current income. A large part of the portfolio is invested in stocks that pay dividend and high-yield credits. The remaining 20% is invested in preferred securities and convertible bonds.
The High Yield Strategy, which is based on asset valuation aims at investing in companies with a wide number of assets to reduce exposure to high defaults and low recoveries. In this case, the firm prefers senior or secured bonds rather than subordinated ones and by focusing on asset valuation, the firm should be able to achieve superior risk-adjusted performance.
Here are some of Hotchkis and Wiley's stocks:
TCF Financial Corporation (TCB): TCF Financial is a Minnesota based bank focused on consumers. TCB emphasizes convenience with supermarket branches, long operating hours, and easy access to deposit accounts. In terms of deposits, recurring service charges range between 1.5% and 2.5% of deposits. Furthermore, TCF Financial applies sever underwriting standards.
Financially speaking, TCF Financial is in good health. Its balance sheet does not include any subprime or low-document loan and the company is engaged in returning value to shareholders. It considers that such action is a necessary tool. I think Hotchkis and Wiley got attracted by the fact that net income stood at $110 million or $0.71 per share and in general, 2011 saw an improvement in all the company's credit metrics. Nevertheless, TCF is still affected by high provisions particularly in its home equity and commercial lending portfolios.
Capital increased to over $400 million and the company has achieved its highest capital levels with 9.9% in common equity and 8.4% in tangible assets. TCF Financial also has $1 billion in liquidity. Management though is still cautious especially because 2011 has been a difficult year in banking.
In terms of future expectations, management considers that 2012 will involve positive events. Indeed, the company entered into an agreement with VRP as regards their inventory finance business, which should create more than $600 million of new loans. Furthermore, a new auto finance subsidiary has started to originate loans in FY2012.
According to management, 2012 will be a building, investing and innovating year. TCF Financial will rebuild its business model to turn the company into a more profitable bank vis-à-vis 2011.
Sanofi (SNY): Sanofi S.A. is a multinational pharmaceutical company with headquarters in Paris. Sanofi is engaged in carrying out research and developing, manufacturing and marketing pharmaceutical products for sale.
Sanofi is carrying out initiatives to develop in emerging markets. Sales therein exceeded 9 billion in 2010. These markets account for 29% of sales and are expected to increase to 38% to 40% by 2015. The company has set its footprint in Latin America and is expanding to Asia. In China, for example, Sanofi acquired BMP Sunstone to strengthen its presence in the country's health care market. In Japan, its joint venture with Nichi-Iko has also benefited its presence in such country, which is the second largest pharmaceutical market across the world. As regards Latin America, Sanofi acquired Medley in Brazil to expand its presence in the country's generic market.
As regards patent expirations, Sanofi has developed a new operating model. The purpose of this new model is to reallocate resources to segments and programs with higher growth. In addition, it should enable the company to reduce costs in R&D and SG&A. Actually, in 2010, the company was able to save costs by 2 billion and is expected to increase such figure by 2015 given the $700 million savings from the acquisition of Genzyme. The acquisition of Genzyme should bring a new source of growth for Sanofi. It will boost the company's revenues and its pipeline. Genzyme pipeline includes Kynamro, Lemtrada, eliglustat tartrate for Gaucher and Clolar for adult acute myeloid leukemia (AML) among others.
Apart from the acquisition of Genzyme, Sanofi has engaged in nearly 37 other deals in 2010. Since January 2009, the company spent about $23 billion in 23 acquisitions. The most important deals include the acquisitions of Acambis Plc, Symbion CP Holdings Pty Ltd., and Zentiva N.V. The acquisition of the latter is expected to strengthen Sanofi's generic business, particularly in Europe. The Acambis deal has strengthened the company's vaccine offering and Symbion enforced Sanofi´s nutraceutical and OTC offerings. Sanofi has also acquired Fovea Pharmaceuticals to increase its presence in the ocular diseases market. TargaGen Inc has improved the company's oncology portfolio. Sanofi has also developed alliances with companies, such as Regeneron, Dyax Corp., Novozymes, Metabolex, Ascenta, Micromet, Wellstat Therapeutics, Merrimack Pharma and Exelixis.
In terms of new products, Sanofi filed for EU and U.S. approval of different products, to wit: Visamerin/Mulsevo, Aubagio and Zaltrap and Kynamro.
These acquisitions along with other deals the company has engaged in have resulted in a strengthened portfolio and that is why Hotchkis and Wiley decided to invest in it. Furthermore, the company has been able to expand its presence in several therapeutic areas, including cardiovascular diseases, diabetes, oncology and CNS disorder. Its leading product, Plavix, aimed at reducing the risk of myocardial infarction and stroke in patients with atherosclerosis, is significantly benefiting Sanofi through its sales. The company forecasts that the sale of this drug will increase in Japan, where the product began to be used for ACS.
Sanofi is also a leader in vaccine operations, where sales have amounted to 3.8 billion in 2010. The portfolio includes pediatric, influenza and adult and adolescent booster vaccines, vaccines for meningitis and travel and endemic vaccines. The purpose of the company is to expand its vaccine pipeline even more.
Terex Corp (TEX): Terex is a construction and mining equipment company that is now trying to change its activities to the machinery and industrial products business. The purpose of this change is to build strong customer propositions that result in high returns on capital.
In 2010, as part of this new strategy, the company divested its mining business. Why did TEX decide to make this change? The reason is very clear. Mining is a highly capital intensive business and it is hard to develop and support new equipment sales. The mining business was sold to Bucyrus, a competitor with significant presence in the mining market.
Regarding Genie-brand aerial work platform business, Terex profits from the high returns on capital this segment generates. Volume is sold into a rental channel. The purpose of the company in regard to this business is to use the relationships it has already set up to improve sales of its compact construction products.
Regarding the construction segment, sales have been improving in the last quarters. The backlog increased 116.8% in the third quarter and orders for its heavier equipment, rigid trucks and material handlers have improved too. The company will also launch new products to boost revenues. Most importantly, the segment has reduced operating losses.
Financially speaking, the company does not have short-term debt maturities and enjoys high liquidity that enables it to strengthen growth perspectives. Hotchkis and Wiley saw that Terex was an interesting pick because the company is making every effort to gain presence in the Chinese, Indian and Russian markets as well as in the Middle East and Latin America. Thirty percent of the sales came from emerging markets. To increase its footprint in China, which is a solid market, Terex acquired 65% of Shandong Topower Heavy Machinery Company. This deal will definitely strengthen Terex's position in the crawler crane market. Terex has also engaged in other deals. For instance, it entered into an agreement with Fujian South Highway Machinery Company to set up a joint venture in charge of manufacturing mobile materials processing equipment.
This development in China and other emerging markets will enable TEX to offset the weak results obtained from the U.S. and European markets.
Fifth Third Bancorp (FITB): FITB provides banking services to corporations and individuals. It operates through thousands of banking centers and in the Midwest and Southeast it has a sizable presence.
For many years it has carried out an expansion strategy combining new branches and acquisitions. In 2005 and 2007, for instance, it acquired the First National Banchsares of Florida and R-G Crown to enlarge its footprint in Florida. It also acquired nine branches from First Horizon National Corporation and acquired First Charter Corporation in 2008. With this deal the company could enter the market in North Carolina and enlarge its presence in Georgia.
Financially speaking, Fifth Third has a diverse revenue base that should boost earnings growth. Today its noninterest income base represents 40% of revenues and interest income should benefit from the CD runoff and the growth in loans in fourth-quarter 2011.
Lately, FITB has taken steps to improve its credit quality. In the last years, indeed, it has engaged in loss mitigation and has taken actions to reduce credit risk. The actions have been translated into better credit quality trends. Management expects that these trends will continue in an upward track in the years to come.
In general terms, Fifth Third is in a sound capital position. Most importantly, it has completed all the government support programs it engaged in during the last financial crisis. Furthermore, it does not have a Temporary Liquidity Guarantee Program (debt) for 2012. In terms of cash, its current level is correct and the bank holds minimal debt maturities for 2013. The company has a strong flexibility too. There is no doubt that all these elements were taken into account by Hotchkis and Wiley to invest in it.
BB&T Corp (BBT): BBT is one of the best banks across the U.S. Its underwriting is sound and did not need assistance after the recent financial crisis. Unfortunately, it is not very well ranked among analysts. They think BBT is not the bank that it used to be. Management hopes to change that view and improve in the following years.
BBT reported earnings of $0.55 per share exceeding the average guess of analysts and reported adjusted earnings of $0.61. The company has been able to change a $0.09 gain and a $0.19 valuation adjustment on foreclosed real estate. Most importantly, operating revenue increased by 3% beating estimates. Net interest margin declined as expected but it then improved reaching peers NIM. Fee income underwent a sequential growth of 4%, expenses grew 1%, and pre-provision profits were up 5% sequentially. BB&T has also boosted lending, particularly commercial and residential lending.
Last but not least, the bank also engaged in profitable deals and has aggressively tried to repay debt.
Now, why do analysts have a bad image about BB&T? Why is it not a beloved bank? Its large exposure to commercial lending. However, that is not the situation and Hotchkis and Wiley noticed it; otherwise, it would not have invested in it. Commercial lending is similar to that of other well-known banks, such as Fifth Third and in some cases, lower than others, as in the case of Comerica (CMA). Although BB&T's net interest margin is somehow exaggerated today, it is not worse than the average. Moreover, the bank was punished for reporting low earnings and returns when Citigroup (C) and Bank of America (BAC) are increasing debt on their books.
In terms of future expectations, BB&T is strengthening its lending activity, improving its insurance industry and its credit quality. Today the stock is undervalued and given the fact that it is not loved by analysts, investors should turn to its fundamentals to see if it is worth investing in.