Jeff Auxier GuruFocus Interview: Part 2
GuruFocus: You’re buying a lot of global brands, and they all had in common emerging market growth, like Proctor and Gamble (PG), Pepsi (PEP), Philip Morris (PM), Johnson and Johnson (JNJ). Is that was a conscious investment theme or is that a coincidence?
Jeff Auxier: Some of the best fundamentals surround the roughly 150 million new entrants that are annually entering the global emerging middle class, which now numbers approximately 1.8 billion. This segment spends between $10-$15 trillion a year. The internet is fueling envy and a new group of consumers seeking truth and trusted brands. Ironically, despite the current global protests against America, there is a powerful desire for quality Western brands. The U.S., France and Norway are the most food-secure countries in the world today. U.S. farmers feed 20% of the world’s population on just 10% of the world’s land. As incomes rise, so does the demand for a better diet and healthcare. Many of the U.S. multinationals enjoy a reputation for quality and have the scale in distribution to meet this growing demand. Poor execution on the part of JNJ and P&G this past year provided attractive entry price points for both stocks. Each company owns a plethora of leading brands that if spun off could provide tremendous returns for shareholders. Over 80% of acquisitions destroy shareholder value; spinoffs have had a much better record of outperforming the averages within 24 months. While Greece and Europe dominate with negative headlines, countries like Indonesia, Malaysia and the Philippines offer exciting underlying trends.
And about Pepsi, he says that it’s been out of favor during the tech years but a lot of defensive names are all the rage, and is your portfolio tilted towards consumer defensive names because of your macroeconomic view, and it seems a more contrarian approach would be a more bullish approach on cyclicals like ArcelorMittal (MT) or Fiat (FIA).
We like products that are purchased because of free will, not a government stimulus program. You have to look at the big picture and the individual businesses. We try to be very disciplined with the price we pay but also about the quality of the business. Once you accumulate debt, historically it is difficult to reduce through austerity. If austerity is too harsh, people riot. It takes time. So we’re in a multiyear deleveraging period, and when economies are deleveraging, low-ticket necessity items tend to have a better risk/reward. China’s fixed investment levels were unprecedented this past decade. The hangover from their massive stimulus is very difficult to analyze. When the government is a big part of creating the demand for your product, like steel, it can be hard to quantify. We need much greater predictability.
Okay. And thinking about Proctor and Gamble, what are your thoughts on its moat in terms of some of those increasing commodity-like industries such as soap, cough syrup, etc., that are subject to private-label competition?
Companies need to constantly innovate to provide better value for their customers. They need to communicate the value. Globally, consumers have been willing to pay up for healthier products that will benefit them longer term. There is a tremendous opportunity for businesses that are on a virtuous cycle working to provide better value for their customers all the time. Unilever has done a good job staying close to their customers and has outperformed P&G, in my opinion, in many foreign markets. P&G is not executing up to its full potential. They may need to reenergize brands through spinoffs. Apple (AAPL) exemplifies the positive result of a tenacious drive to provide a superior product for the customer.
How would that same question apply to some of your other holdings, like Johnson and Johnson, or Molson Coors Brewing, or maybe Philip Morris?
Philip Morris has operationally done an excellent job since the split from Altria (MO). Johnson and Johnson suffers from a lack of quality control in many of their products. These are fixable, and again the tremendous lineup of leading brands offers investors good potential with spinoffs.
The other one was Molson Coors Brewing (TAP).
Oh yeah, again, they’re really cheap. They’re the oldest brewer in North America, and the stock is running about 10-11 times earnings with a very strong balance sheet. If you look at what Heineken is bidding for Asia Pacific Breweries (15-17 times cash flow), Molson looks like a bargain. The company has been innovative in coming out with new products, especially in the craft beer area. Their customer base is mostly unemployed, so that’s kind of the problem. But usually if we can buy a beverage company at 10x earnings, we’re pretty patient. Historically it’s been a pretty good entry point.
Okay. Is that why you would invest in American brands over European brands or other brands in China or Brazil?
We just want a quality brand and honest, diligent management where we can find it. The problem with many foreign businesses is the integrity of the accounting. We like Western accounting better. So we would much prefer a company that makes a quality product with conservative accounting. The added transparency on the Internet benefits the good operators as the news of poor quality and dishonest behavior travels fast. We want businesses to focus their energy on a superior product or service, not financial engineering.
Okay. Great. Did you and Charlie talk about the euro zone? Where do you see that situation going and do you think any of the countries will default?
Well, Greece has been in default over 50 percent of the time since the early 1800s. It is built into their DNA. They never had the finances to join the euro zone in the first place. Spain’s recession has been more of a traditional downturn driven by the excesses of real estate development. The inflexible labor markets throughout Europe add to the challenges. The perception of a “safe government” is quite the oxymoron. According to Reinhart and Rogoff, if you look back eight centuries, only six countries have paid their bills. Only six in eight centuries. Throughout history where there is an excessive accumulation of debt, restructuring follows. This leads to bargains opportunities. Recently Carlos Slim announced that Europe is now a good buy. Remember, he was extremely active in buying businesses in 1982 after Mexico defaulted on their debt. J. Paul Getty started buying oil stocks under book value after 1930 during the Great Depression. Historically, the great investors come alive in panics, recessions and depressions because of low prices--that’s when you really want to work overtime as an investor. Attractive prices should dictate higher activity.
Charlie: Yes, I have a question. Do you think the opportunity is more in stocks or in debt, or both? If you look at Spain, the biggest companies in Spain, one is a bank, Bank Santander (STD). The other is Telefonica (TEF), a phone company. What other opportunities do you see there?
I think there are huge opportunities with Telefonica. They have solid assets that can be monetized. They recently cut the dividend, so we actually have been buyers of both the debt and stock. We like the Spanish-based companies that are globally exposed--and Telefonica’s less than one-third in Spain, they’re in Germany, they’ve got assets all over Europe, and then also in Latin America. So, on a price basis, since they have cut the dividend, the debt is interesting. They have a number of companies that they can take public where they can reduce the debt.
What do you think about the U.S. housing market? Where do you think it will go?
The problem I have with housing is the artificial repression of our interest rates. The Federal Reserve has removed the free market pricing mechanism. It is masking the needed fiscal reform. The U.S. provides $400 billion a year in housing subsidies. There is no stigma in strategically defaulting. With easy money people are gaming the system. What would happen if you brought the free market back to the bond market? According to Jim Grant, the Greek long bond yielded only 20 basis points over the German long bond back in 2005. Look what happened to those interest rates in Greece. Look at California, the world’s seventh largest economy, and they have just approved a massive $100 billion bullet train. The history of railroad defaults in the 1800s is not encouraging. Too big to fail? What if California or Illinois needed to be bailed out? What happens to housing values if the market were to price the risk? Government intervention in Japan led to a housing market that has been in a downward spiral for 17 years. It is very difficult to get a true read on the supply and demand for the U.S. housing market today.
Okay. Makes sense. Are you optimistic about natural gas? How are you investing in it, and what is your outlook on fossil fuels versus alternative fuels?
Human ingenuity and the tremendous advances in technology contribute to the speculative nature of undifferentiated commodities. Through fracking and horizontal drilling we have glutted the market with natural gas. We have the technology to just totally meet all of our energy needs, it’s pretty exciting, and it’s really politics that is standing in the way. Natural gas at these prices is maybe equivalent to $20 oil, so that’s really already leading to a huge competitive manufacturing advantage. Now companies are looking to shorten their supply chains. In China, natural gas is maybe anywhere from 6 to10 times more expensive, same with Europe. Instead of buying direct producers, we would rather buy the beneficiaries of lower inputs. We like companies that benefit from lower technology costs, and we like companies that benefit from lower energy inputs. The technology exists for much lower oil prices as well. The branded packaged goods companies should benefit from those lower inputs. But to play it directly is really tough. I remember back in the early 1980s witnessing the boom-bust cycle with the stock of Texas Oil and Gas. In the late 1970s it was a top performing natural gas producer, and then once that boom busted, it was flat for years. Commodities are tough. We are coming off a China-driven 115-month commodity boom that exceeded the tech boom and the housing boom in duration. Once the public is sold on the trend it can become treacherous. Lending standards tend to gets sloppy. Wall Street kind of went crazy with the financing of Chesapeake. It was similar to Enron, where the off-balance sheet funding seemed like it would never fall out of favor. If we were to invest in the sector it would be with a company like Apache.
Why do you like it?
They’re just really sensible about how they acquire reserves, sport a strong balance sheet and sell at a steep discount to reserves.
Alright. I think you touched on this with Charlie a lot, about your mentors? And so do you have anything to add? Were there any moments in your investing that changed your views, or were eye opening, throughout your career. Might have changed your path a little bit, or someone you met that changed your thoughts about things?
In business, primarily Robert Pamplin. The call in 1982 to Warren Buffett was critical in establishing the framework to endure longer term. The best thing I did was to energetically focus on that price-value-margin of safety approach. An example of how valuable the lessons proved: I had a client in 1985 who entrusted me with $1 million and we just sat down and we went through all the Berkshire Hathaway (BRK.A)(BRK.B) annual reports and started attending the Berkshire meetings. That $1 million compounded to $6 million by 1992. Achieving those results while employing a systemic, low risk approach hooked me for life.
Yes. Just some comments here. You were really lucky to get Warren Buffett to answer your call in 1982. These days if you call him maybe even his secretary is too busy to answer your phone.
He has contributed so much for so many with his education on the proper way to invest. Like what Gurufocus is doing today. Capital allocation is critically important in a free market system and if it’s done poorly, the consequences can be devastating to people’s lives. Gurufocus provides a very valuable educational service—one of the best I have seen. It still comes down to the daily voracious researching. You can have a strong track record, but if you’re not committed daily to a rigorous fact finding effort it is difficult to protect against permanent capital loss. Gurufocus provides the sound fundamental approach needed to endure the most difficult market conditions.
Thank you very much.
Phenomenal, what you guys do.
I have a last question. You live on a farm right?
Does that give you an advantage in investing?
I think it does. We actually have a producing farm with cattle, timber and hazelnuts. We export to China We see supply and demand at a very base level. Supply and demand to me is critical in investing. Humility is a big component as there are no shortcuts in farming. The work has to get done every day. You need to get a high quality product to the market. It is not easy. For kids it’s a great training ground. Farming combines biology, chemistry, mechanics, engineering, mathematics. I purchased the farm in the late 1980s and in hindsight it was one of the best moves of my life. Investing and farming are similar--you’re planting and compounding. A true investor tends to plant in the “hopelessly out of favor” and then harvests during “emotionally euphoric.” Like farming, the investor needs persistence and dedication to stick to a disciplined research regimen. An effective risk manager combines humility, persistent fact-finding and cumulative knowledge together with the proper temperament. Mr. Buffett’s advice about living far from Wall Street was so valuable--I took it to heart. John Templeton is another example of an outstanding investor who did much better after moving to the Bahamas from New York. Better to do your own thinking far from the emotions and swirling rumor mills.
Thank you very much. It was a great pleasure to talk to you.
Thank you, any time. You have a great site.