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Holly LaFon
Holly LaFon
Articles (8179) 

Why Steven Romick Thinks CVS, WMT and MSFT Are Cheap

July 05, 2011 | About:

Steve Romick is the portfolio manager of FPA Crescent Fund he founded in 1993. The firm states in its “Contrarian Policy Statement” that they are “absolute value investors” and they “seek the out-of-favor, unloved or misunderstood.” Romick has made a 10-year average return of over 11% which places him in the top 1% of money managers. He is the only fund manager whose shorts GuruFocus tracks.

In a recent interview on WealthTrack with Consuelo Mack, Steven Romick of FPA Funds discussed what characteristics he looks for in investing opportunities right now. Romick named several stocks he believes are cheap, among them, CVS/Caremark (NYSE:CVS), Walmart (NYSE:WMT) and Microsoft (NASDAQ:MSFT). Here’s why.

Walmart (NYSE:WMT)

Over the last decade, Walmart has had several noteworthy trends. Its stock only rose 9.39% and currently trades for around $53. Despite the stagnant price, Walmart’s earnings have grown consistently over the same time span. It had EBITDA of $12 billion in 2002, and $25.5 billion in 2011. Due to the increased earnings, the stock is even cheaper than it was in 2009 and the P/E multiple has dropped to 12.77.

Romick said that his fund treats Walmart as an “infinite duration bond with a rising coupon.” It has increased dividends 18% compounded over the last decade (10 points better than earnings), and repurchased 7 million shares.

Ubiquitous as Walmarts seem, the company still has room to grow. Domestically, it can move into many new metropolitan markets and make its current stores more productive. Internationally, it added 500 units and exceeded $100 billion in net sales overseas for the first time in 2010. The company expects 8 to 10% growth in overseas markets in 2011 and has its eyes particularly on Brazil, China and Mexico.

Romick has owned Walmart shares since the fourth quarter of 2009. He added 1,125,000 shares in the first quarter 2011 and now owns 3,400,000.

CVS Caremark (NYSE:CVS)

The healthcare sector attracts Romick as he is looking for industries where the wind is at his back – that offer growth potential but that the marketplace might not completely understand.

CVS Caremark is the largest pharmacy care provider in the US and one of the largest pharmacy benefits managers (PBMs). One out of every five retail prescriptions written in the US is filled by CVS.

Romick deems CVS a good investment because the aging population means more people will need drugs and scripts to treat the various health problems that arise as a person gets older. When more people come into the store for drugs, they will likely also purchase products at the front of the store. Persons 65 and older represent 12.4% of the population in 2010. That number will grow to about 19% of the population by 2030, according to the Administration on Aging.

Furthermore, the generic drug market should spike 2012, when every class of drugs should have a generic alternative. Within the next five years, studies show that approximately $90 billion of branded drugs will lose their patents. This benefits CVS because as more drugs go generic, the distributor is eliminated and the pharmacy’s margins go up, says Romick. Canadian pharmacy chain Jean Coutu Group Inc. posted its financial results on Tuesday for the quarter ended May 28, which demonstrated this effect. Sales of nonprescription drugs increased 6.6%, accounting for 9% of the pharmacy’s total retail sales, which helped the company’s earnings rise to C$49.4 million, from C$43.9 million a year earlier.

CVS generated record free cash flow of $2.8 billion in 2010, up from $1.5 billion in 2009, and it has raised dividends every year since 2003.

Romick began buying shares of CVS in the third quarter of 2010 and bought 1,808,915 shares in the first quarter 2011. He now owns 6,292,000 shares.

Microsoft (NASDAQ:MSFT)

Romick believes that Microsoft is cheap because it has lost its way and not kept pace with new technology, specifically tablets and smartphones. He also echoed David Einhorn’s comments regarding CEO Steven Ballmer, commenting obliquely that “it hasn’t been managed as well as it should be, and any change of management would be viewed positively by the Street.” That creates huge upside potential.

Romick believes that despite the overhang of management and slow innovation, Microsoft is still a good business with a lot of cash flow and cash on its books. Microsoft’s balance sheet shows about $36.7 billion in cash and $40 billion in long term liabilities and debt. Revenue grew to a record $62.5 billion in 2010, an increase of 7% from the previous fiscal year. During the dot-com era, Microsoft sold for about $46 per share, with a PE ratio of 50, and generated gross profit of $17 billion. As of July 2011, it trades for $26 per share, has a PE ratio of 10.6, and generated gross profit of $50 billion.

Microsoft became a part of Romick’s portfolio in the third quarter of 2010, and he added each quarter since. He owns 5,250,000 as of March 31, 2011.

The full video of the WealthTrack video is below:

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