After spending several years buying the most battered financial companies of the 2008 to 2009 financial crisis, Bruce Berkowitz this year is busy loading his mutual fund, the Fairholme Fund (FAIRX, Financial), with shares of the government-rescued Fannie Mae and Freddie Mac. He has also opened his own hedge fund. But before these periods, when he was running a successful and rather risk-averse mutual fund and named hedge fund manager of the decade, he worked with two men, Larry Pitkowsky and Keith Trauner. In 2010, these two investors left to found a separate firm, the GoodHaven Fund (GOODX, Financial).
Pitkowsky and Trauner’s fund operates on many of the same principles that initially made the Fairholme Funds great. The firm takes a long-term view, and, according to its website:
- Focuses on a few carefully chosen companies whose securities appear significantly undervalued.
- Likes companies that have strong and enduring businesses run by exceptional owner/managers.
- Pursues other value investing strategies such as those related to risk arbitrage, spin-offs and companies in bankruptcy.
- Does not limit itself to any geography, sector, industry or market cap.
Year to date, GoodHaven has underperformed the S&P 500, returning 14.81% compared to 19.79%. Annualized since inception, it has beat its benchmark, returning 14.15% compared to 12.41%.
The fund has heavily weighted its capital into a few companies, with the top 10 holdings composing almost half. Its top five positions, as of Sept. 31, are Hewlett-Packard (HPQ, Financial) (8.0%), Spectrum Brands Holdings (6.5%), Barrick Gold Corp. (4.7%), Walter Investment Management Corp. (4.7%) and Microsoft Corp. (MSFT) (4.2%).
Hewlett-Packard (HPQ, Financial)
Hewlett-Packard comprises 8% of GoodHaven’s portfolio as its largest position. The managers disagreed with a short-seller’s pronouncement last year that the company exemplified “the ultimate value trap,” due primarily to its declining PC business. In their 2013 semi-annual report, they said:
“Due to our willingness to buy under stress and subsequent appreciation, HP has become our single largest equity investment. We believe the company's management has stabilized under Meg Whitman's leadership, although it will take stronger end markets for the company to see top-line growth. Our best guess is that revenue growth is still a year or two away and that, in the interim, expected cash flows should continue to support a program of debt reduction, share repurchases and dividends. HP has exposure to potential weakness in Europe and China, but we believe that much good has been accomplished under tough conditions. With some modest relief from general economic conditions, we think HP's shares can appreciate further given low earnings and cash flow multiples that continue to reflect skepticism about the future.”
In one year, Hewlett Packard’s stock has gained almost 101%, reaching a new 52-week high this week and trading around $28.19 a share on Friday.
As GoodHaven expected in its letter, Hewlett Packard’s revenue declined 3% for the fourth quarter and 7% for full fiscal-year 2013, compared to the prior corresponding periods. For the year, it returned to a profit, reporting $2.62 net EPS, from a net loss per share of $6.41 in 2012.
The company in the fourth quarter also continued to reduce its debt, paying down $1.3 billion, its seventh consecutive quarter to reduce it by more than $1 billion. It also spent $763 million on dividends and share repurchases during the period, paying a quarterly dividend of $0.15. Cash flow generated totaled $1.9 billion.
Hewlett Packard’s 10-year revenue and earnings history:
Hewlett Packard trades with a P/E of 10.73, P/B of 2.2 and P/S of 0.48%, around a two-year high.
Spectrum Brands Holdings (SPB, Financial)
Spectrum Brands Holdings is a diverse, $3.69 billion market cap company that the firm no longer wants to buy, as they said in their semi-annual letter:
“As portfolio managers, we do not automatically buy a security if new money enters the Fund unless we think it has the right ratio of risk versus reward. We still own and like Spectrum Brands as an investment, although significant appreciation caused us to halt new purchases. As a reminder, Spectrum sells Rayovac batteries, a variety of branded insect repellants, an assortment of branded pet supplies, George Foreman appliances, Remington shavers, and through its recent acquisition of HHI Brands, Kwikset locks, Baldwin hardware, and Pfister faucets. We believe that Spectrum has further upside, but not quite enough to cause us to buy more at recent prices. We like management's execution and the profile of the business and its products – mostly consumer staples that people need rather than want. As is true of many businesses today, organic top-line growth is slow and cost pressures, particularly from China, remain a concern. Nevertheless, we believe the company should generate free cash flows over the next couple of years that will be put to good use.”
Year to date, Spectrum’s stock has gained 56%, trading around $70.13 a share on Friday. The company in November announced record financial results, boosted by the acquisition of HHI, that exceeded its full-year guidance. Spectrum had $4.09 billion in revenue, up 25.6% from 2012. Its net loss totaled $55.2 million due to $122 million in costs related to extinguishing $950 million senior secured notes in the third quarter. In 2012, it earned $48.6 million.
It also ended the year with $207 million in cash. It will use its free cash flow to pay down debt and balance sheet leverage in 2014.
Spectrum 10-year revenue and earnings history:
Spectrum trades with a price, P/B of 4.07 and P/S of 0.89, all near their respective five-year highs.
Barrick Gold Corp. (ABX, Financial)
GoodHaven commented extensively on Barrick Gold Corp in its semi-annual letter:
“During and subsequent to the six-month semi-annual period, we increased what had been a modest investment in Barrick Gold, a miner with huge and low cost reserves that has stumbled into a Bermuda triangle of project mismanagement, lower gold prices, and excessive leverage. Frankly, we started at too high a price, have absorbed losses to date, and were less critical than we should have been about project milestones and increasing leverage given past management success. That said, sometimes an early mistake can lead to a bigger opportunity.
With some significant governance and management changes, a much lower stock price, and likely asset write-downs ahead, we decided to run towards the fire. Barrick's board replaced the CEO, adopted new more sensible capital allocation policies, and worked rapidly to repair relations with regulators critical to its large, low-cost Pascua Lama project in Chile and Argentina. Although investing in a goldminer carries certain reputational risks,10 we significantly increased our investment in recent weeks and have been paying stock prices unchanged from more than a decade earlier. Gold prices have declined more than 35% from their peak of a couple of years ago despite worldwide demand for physical gold that appears to remain strong. The recent wave of negativity exacerbated by a rapid decline in gold bullion prices seems to be at crescendo levels.
Reducing debt and putting Pascua Lama back on track remain the largest challenges facing the company, although significant debt maturities are mostly longterm. We think that using reasonable cash flow estimates from here yields a strong case for a sensible investment in a highly depressed security. Unlike most, we think of gold primarily as an alternate currency – one that can't easily be printed and which, over thousands of years, has retained general attractiveness to people around the globe due to its intrinsic properties. If gold plummets further and remains depressed for an extended period, we will probably lose money in this investment. However, we believe Barrick's stock not only appears to be a bargain based on expected cash flows, but also a valuable call option offering potential hedge protection against inflation or currency stress caused by ongoing and historically unprecedented monetary stimulus.”
Walter Investment Management Corp. (WAC, Financial)
Walter Investment Management is a consumer loan servicing company with a $1.32 billion market cap. Its stock declined 17% year to date, to $35.67 a share on Friday.
GoodHaven commented:
“Our investment in Walter Investment Management declined in value for the six months ended May 31, yet we remain positive on the business. Much progress has been made in growing the asset base, applying proven systems to acquired businesses, and financing its rapid growth. Although somewhat complicated and financially leveraged, Walter's primary business is "servicing" mortgage loans that are less than the highest quality, where borrowers typically have fewer financial resources and greater risks of delinquent payments or default. In simple terms, Walter collects payments, contacts delinquent borrowers, and tries to maximize the cash flow to investors from these loans.
In the last few years, there has been a sea change in this business, where the historical participants – mostly large banks – have sought to outsource these activities for a variety of reasons. In our view, this shift is permanent and ongoing, and there are only a handful of companies positioned to potentially benefit. As a result, Walter has grown rapidly and still has potential for further growth. There is execution risk anytime a company grows rapidly and when growth is financed by debt, however Walter's cash flows still appear to be increasing at a fast rate, making its valuation seem inexpensive despite the significant appreciation we have enjoyed to date.”
The company has grown rapidly recently. In the third quarter, its net income jumped to $72.7 million from $6.4 million the previous year, and “core earnings” increased 211% to $87.6 million. Total revenue increased to $489.2 million from $149.1 million. The revenue increase was primarily due to increases in its net servicing revenue and fees, sales of loans and fair value on reverse loans and related HMBS obligations.
The company raised its full-year 2013 EPS guidance due to strong market conditions, strong pipeline and new acquisitions.
Walter Investment’s 10-year revenue and earnings history:
The company trades with a P/E of 6.5, P/B of 1.2 and P/S of 1.04, near a three-year low.
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