When Marty Whitman stepped down in 2012 from managing the flagship Value Fund at his firm Third Avenue Management (Trades, Portfolio), it was during the midst of a difficult environment for deep value investors. Robert “Chip” Rewey now oversees the Value Fund and four others at Third Avenue and is staying true to Whitman’s style, which includes maintaining a concentrated portfolio with an eye towards long-term returns.
Mr. Rewey recently took the time to answer questions from GuruFocus over email about topics ranging from his current holdings to book recommendations.
Please tell us about your background and how you got your start in investing
I have always been one to try to figure out how things work. When I was given walkie-talkies for a birthday gift as a child, I had more fun taking them apart to try to see how they worked than by talking on them. This intellectual curiosity naturally drew me to the analysis of companies’ financials. Where is the true value-add in a company’s value proposition? How does the balance sheet either support or refute the fact that this management team has created value for shareholders? Investing offers limitless opportunities to learn.
My first financial job out of college was as an acquisitions analyst at the Associates First Capital Corporation where we were buying portfolios of mortgage backed securities from the Resolution Trust Company and stressed banks. This experience, of buying pooled mortgages at severe discounts to par, helped me avoid significant losses in the financial crisis of 2007-2009 by selling positions with exposures to stressed CDO portfolios. I remembered buying pooled vehicles at cents on the dollar when the generally accepted market belief was that these structures could not trade below par.
Which investors had the most influence on your investing philosophy?
Marty Whitman and Laura Sloate have had the greatest impact on my investment philosophy. The lessons that have stuck the most with me are the long term horizon, the focus on the fundamentals of the company and the business (as opposed to short-term fluctuations in security prices) and the importance of assessing creditworthiness and downside protection in every investment decision. Marty espouses a “Balance Sheet first” mantra to investing, to ensure an enterprise has the financial strength to weather periods of economic weakness, in addition to book value compounding and buying at a discount. Laura also begins with credit worthiness of a company and similarly does extensive fundamental research on the company, including management and industry evaluations.
What is the process you use to narrow down the search for a value investment? Do you use a screener?
We typically screen for several quantitative and qualitative factors to narrow down our investment universe. Quantitative factors include price decline, strong history of book value compounding and strong balance sheet as measured by low financial leverage and no cash flow draining contingencies. Qualitative criteria include focusing on industries or segments of the market in turmoil (e.g. oil and gas) or that we believe are misunderstood by the market (e.g. holding companies).
What are your top criteria to determine whether a company is high value?
Ultimately, the only way to determine, with conviction, that a company is high value is through an in-depth study of the company. I look for a company’s ability to compound book value. I start with the balance sheet to see credit worthiness, historical book value and retained earnings growth. Then I focus my research on the ability to continue to compound book value at these historical rates or higher.
Do you meet with management? If so, what qualities do you look for?
Yes, we meet with management as part of our thorough due diligence process. We look for like-minded management teams that have a solid understanding of their company’s ability to compound value, an understanding of the key variables to creating that value, and a longer term plan to fund the company’s growth and maintain their competitive advantage that leads to superior value creation.We often find that management can be key in spearheading actions – such as restructuring or asset sales – that ultimately unlock shareholder value.
Can you explain your investment thesis for Vodafone (VOD, Financial)?
We think Vodafone’s investment in “Project Spring” will pay off in better service quality, which will enable better customer retention and acquisition, along with the ability to maintain competitive pricing. In this sense we see VOD as a multi-year compounder. We could get a more near-term closure of the value gap to our NAV target through "resource conversion" events including the separation of its Indian unit and a merger of its European unit.
If you believe that our dollar is in serious trouble, what industries or companies do you believe will prosper in spite of the dollar weakness?
As fundamental value investors, we do not make macro calls on currencies. We do study a company’s ability to maintain profitability in a period of currency volatility, including the ability to competitively source raw materials and labor, and the ability to raise prices if necessary. Actually, the converse of the question is true today. The U.S. dollar is strengthening vs. global currencies, which negatively impacts the ability of export oriented U.S. companies to compete globally.
What is your view of Apache’s (APA, Financial) move to focus on its North American assets? How is this expected to impact the business in the future?
We applaud the focus of APA’s new CEO on North America, specifically in reducing costs, refocusing on value added activities vs. the historical growth biased activities, and the improved balance sheet metrics resulting from the sale of foreign assets. APA has leading positions in the Permian Basin and Eagle Ford Basin which should allow it to provide strong returns even at current oil prices.
Can you walk us through how you determine a company’s intrinsic value?
We use many methods to determine intrinsic value, preferring to triangulate the results of several approaches including book value compounding, sum-of-the-parts studies, peer multiple analysis and discounted cash flow analysis.
The commonality is our starting point of balance sheet analysis. First, we determine creditworthiness by finding low leverage and a business model that does not rely on continued access to the capital markets. Then we look at the company’s ability to generate superior returns on equity. Historically this is seen through book value growth, specifically retained earnings growth, confirming that this company can add value over time. Then, our job as analysts is to assess the factors that historically led to this value creation, and to determine if the company will continue to be able to compound book value growth at double digit rates going forward. Questions we ask include: the markets the company operates in - are they growing? Is the company able to gain, or at least profitably hold share? Is the company able to raise prices to respond to inflationary shocks? Are there any new company entrants, or industry changes that might compete more effectively in the future? Responses are not meant to forecast an income statement, but to verify that the conditions that allowed the company to succeed in the past can continue, and/or the company is able to profitably adapt to evolving business conditions. Once answered positively, we determine our own NAV.
Can you tell us of an investment mistake you’ve made and what you learned from the experience?
From a pure investing standpoint, a lesson I have learned is to avoid companies that are over levered. More broadly, I believe that one does not learn from what one does right, but only in going back and studying one’s mistakes. No two situations are exactly alike, but there are parallels that are important in risk avoidance.
What are your guiding principles when deciding whether to sell a holding?
My sell discipline is simple –Â i) sell when a stock achieves your NAV driven price target, ii) sell when something happens and your investment thesis is broken, or iii) sell to fund a better risk vs. return situation.
Are there any specific industries or sectors where you’re seeing bargains?
Today we see good opportunities in U.S. regional banks, U.S. housing and selective opportunities in energy, mainly exploration and production companies. We seek out investments in individual companies as opposed to industries, but we’re seeing more opportunities in those areas. The Value & Small-Cap Value teams have focused on regional banks that are strong underwriters with excess capital, leading to depressed earnings due to relatively subdued loan demand and squeezed interest margins. The problems that banks faced going into the financial crisis are now resolved. No longer are banks full of troubled loans and facing liquidity problems. Now, banks are awash in excess capital due to shifts in regulation and are facing a tepid loan growth environment due to a slower than historical economic recovery. Over time, we expect banks to better manage and deploy this excess capital, which should be helped by improving loan growth and a steeper rate curve that will once again provide a positive investment spread. When we compare regional banks to money center banks, we find that the former are more attractive based on a price to tangible book basis with a better return profile, are very well capitalized and provide downside protection through extremely strong balance sheets, as verified by their above average performance in the “stress tests.” Comerica (CMA, Financial) is a high conviction name that fits that description perfectly.
Where are you seeing opportunities in regions other than the U.S.?
We recently added positions in Canada, specifically in the forest product industry, which we believe is attractive today both due to U.S. housing strength and a likely worsening of timber supply due to the mountain pine beetle infestation.
We are seeing many potential opportunities in Europe today, due to our belief the creditworthiness profile of many companies in the region has improved and the price discounts vs. our NAV’s have begun to look attractive.
What books would you recommend to a beginning value investor?
If I had to recommend one book it would be Marty Whitman’s ”Modern Security Analysis” – it is a fresh update incorporating the pillars of our time-tested investment philosophy at Third Avenue. I would also recommend Malcolm Gladwell’s “Blink,” where the message is, once you have done your work and built your experience, to trust your instincts.
If you were to give one piece of advice to a beginning investor, what would it be?
Think for yourself.
