In the current environment, Robert is "finding value in many sectors". In his most recent shareholder letter, he wrote:
We are currently identifying investment opportunities in companies that we believe have been over penalized by irrational fear in the market. Many of the Fund’s current holdings in beat-up sectors, particularly the consumer discretionary and financial sectors, are trading at or near historic lows based on our measures of intrinsic value. Consumer discretionary stocks and financial stocks thrive during periods of declining interest rates and declining inflation. We believe current economic conditions in combination with government monetary policy should result in a period of declining interest rates and lower inflationary conditions... We believe “recession risk” is more than adequately built into current stock prices
His comment about Citigroup, JC Penney and Cisco:
Over the past six months, Citigroup experienced material write-offs in sub-prime mortgage investments, replaced the former CEO who many analysts and company observers believe did not show the appropriate leadership in handling the company’s sub-prime related investment exposure, and improved its balance sheet by raising more than $20 billion of capital from sovereign funds (such as Abu Dhabi and Singapore), and former CEO Sanford Weill. Citigroup has been the subject of many negative articles and has been the subject of daily rumors regarding its financial health and exposure to additional bad investments and loan losses. In the past six months, the stock has declined from the mid-fifties to its current price of $27 per share. Despite all the current negative news and speculation surrounding Citigroup, we believe investors are undervaluing the earnings potential of the company, its outstanding international franchise, the impressive credentials of the new CEO and Chairman (as well as their support team) and their outstanding contacts around the globe (which should translate into profitable business opportunities).
The CEO’s decision to consolidate company-sponsored Structured Investment Vehicles was a correct strategic alternative and removed a major source of uncertainty about Citigroup’s financial health. We believe the recent capital investments in Citigroup are another indication that current prices represent a discount to the company’s intrinsic value. We would rather invest with the financial experts representing the largest sovereign investment funds in the world (who we believe examined every aspect of Citigroup’s books as part of their due diligence) than with the analysts recommending the short sale of Citigroup at current prices. We wrote a letter to the new CEO of Citigroup requesting that the company implement a 30-40% dividend cut and congratulated him on his quick decision to consolidate the outstanding Structured Investment Vehicles underwritten by Citigroup. We view management’s decision to cut Citigroup’s dividend by 40% as a wise move and a positive action under the current circumstances. The dividend cut was necessary to preserve capital in the short run and can be reinstated at a later date. The dividend cut should result in capital savings of $4-5 billion a year and still provide shareholders with an approximate 5% dividend yield at current prices. We believe Citigroup has the ability to re-establish the dividend at 2007 levels within 24 months, based on our expected earnings power in 2009 and going forward. After performing a thorough and detailed analysis of Citigroup’s current and past financial statements and footnotes, we believe the company is capable of earning $4.00 or more a share in 2009. In reaching our conclusions, we conservatively assumed provisions for losses of $81.0 billion between 2007 and 2009 (which averaged $8 billion a year in the recent past) and write-offs of $50 billion over the same time period. The aforementioned provisions and write-offs would produce a reserve for bad debts of 5.3% of estimated loans outstanding by year-end 2009 (compared to a reserve percentage of 1.7% in the recent past). If our assumptions about Citigroup’s future cash generating power are correct, we expect Citigroup’s shares to be valued at $45.00 to $50.00 by mid 2009, which would represent an 80% to 100% return to the Fund over the next 18 months. We believe the current price of Citigroup is unrealistic relative to its long-term potential and are ready to endure short-term pain for the potential long-term gain.
Within the consumer discretionary sector, we are finding compelling values, particularly within the retailing industry. Fear of recession is one of the major reasons that JC Penney common stock has fallen from an intra-day high of over $87 less than one year ago to a current level of under $40. According to conventional wisdom, JC Penney, a mid-line retailer, is just beginning to feel the effects of a middle class slow down, and has embarked on an aggressive store expansion program at exactly the wrong time. We, however, contend that even in a recession, JC Penney’s earnings power should reach $3.75 a share and the company should be, in our opinion, worth $56 per share by mid 2009. There are several value-enhancing catalysts that we expect to drive earnings power in 2008. The new “American Living” concept being rolled out in over 600 stores looks promising. Also, we expect the company’s conservative inventory management and strong Internet business growth to be key drivers of enhanced profitability this year. We also believe the company could significantly reduce capital spending and make better use of its free cash flow with an aggressive stock buy back. It is our belief that these catalysts would more than offset a potential slow down in sales from a consumerled recession. JC Penney is a world class retailer with world class management. Unfortunately, it is being grouped together with average retailers. The stock price is suggesting JC Penney could become a long term casualty of a consumer-led slow down. We firmly disagree with this premise.
Cisco is another company that, in our opinion, also has become materially undervalued. We recently added to our position in this well-managed leader in expanding Internet capacity. We believe Cisco continues to represent outstanding value despite the market’s disappointment with management’s recent prediction that growth would slow from mid-double digits to low-double digits. The Fund has profited from its initial purchase of Cisco in 2005 and hopes to profit further from the company’s strong worldwide technological excellence and ability to provide the equipment necessary to add to the Internet backbone in order to satisfy the thirst for worldwide video capability. We believe the company’s low-double digit growth potential is not being properly valued by the market place.
Read his complete shareholder letter: http://www.olsteinfunds.com/TOFAF-Semi2007.pdf