David Herro is a renowned value investor who is the chief investment officer of international equity at Harris Associates. He co-manages the Oakmarks International Fund (OAKIX) (which is closed to new investors), the Oakmarks International Small Cap Fund (OAKEX) and the Oakmarks Global Select Fund (OAKWY). All of the Oakmark funds have outperformed their respective benchmarks since the bottom of the financial crisis in 2009. In 2010, MorningStar named David Herro one of its fund managers of the decade. While David Herro was a guest host on Bloomberg Surveillance in September, he shared his three-fold formula for identifying value in the stock market
After Bloomberg applied Herro's criteria to the S&P 500 Index and found 24 value candidates, and here are a few of those candidates.
Aetna Inc. (AET), Coach, Inc. (COH), Bed Bath & Beyond Inc. (BBBY), Deere & Co. (DE), Exxon Mobil Corp. (XOM), Intel Corp. (INTC), Macy's, Inc. (M), and Paccar Inc. (PCAR)
Summary of Herro's interview with Barron's
In a new interview with Barron's, Herro discusses his investment philosophy and his investment thesis behind his current holdings. He discusses investing in companies that produce Luxury Brands as a way to invest in emerging markets indirectly and that he is currently underweight emerging markets. He is currently looking for value in develped markets where he can find undervalued Luxury Brand companies that have emerging market exposure. Herro discusses why he isn't bullish on Brazil in the short term as he feels that many equities are overpriced. In the interview Herro goes on to talk about 12 global equities that he likes in Developed Markets that are priced just right. He also talks about Japan, how the devaluation of the yen is leading to high corporate profits for Japanse companies and how he is overweight in Japan and is starting to trim back his holdings. He doesn't believe that Europe is falling into a downturn, and he believes that the U.K, Ireland, Spain and Scandinavia are OK. He goes on to say that Germany is hanging on, and Italy and France need structural reform to free up their labor markets so people won't be afraid to invest in France and Italy. Herro also warned that the United States shouldn't follow the European Model or the U.S. will end up like Europe.
Barrons.com: How are you positioned in emerging markets?
Herro: We are underweight in emerging markets. There was a time when we were more than 20% in emerging markets. Just on valuation, I am somewhat bearish until stock prices come down. I am a long-term bull on emerging market economies, but at this stage, I am not a bull on emerging market stocks. Investors should be cautious about emerging market stocks until prices in emerging markets fall off, and it is safe to look at them again.
Q: But what about the power of the emerging market consumer and all that future growth?
A: You can buy companies in developed markets selling at much better values, with exposure to structural growth in emerging markets like Kering(PPRUY), (KER), the owner of Balenciaga and other luxury brands; Diageo(DEO, Financial), the global drinks company; Daimler (DDAIF, Financial), (DAI) and Bayerische Motoren Werke (BMW), the luxury auto producer. Compagnie Financiere Richemont (CFRUY), (CFR) – its big brand is Cartier. Prada(PRDSY, Financial)Â at this price is also attractive. In our core international fund, our only directly-domiciled emerging market stock is Samsung Electronics, which is 2.6% of the fund. On revenues, we are probably in the low to mid 20% emerging markets exposure in that fund.
Q: Why luxury goods producers?
A: They benefit from the move in emerging markets as people shift up from the lower and middle classes into upper classes.
Q: What is the advantage of getting emerging market exposure indirectly?
A: You get lower-priced stocks, stronger corporate governance, and while emerging markets pick up, these companies are doing well in Europe and the United States. The trend in emerging markets is for the consumer to get stronger and stronger over time so the best way to take advantage of this is to buy low-priced stocks based in the West with a lot of exposure to … (please continue to the next page …)
Q: How does Federal Reserve action, and the eventual rise in U.S. interest rates, affect your decision making?
A: Right now, interest rates are so artificially low. Unless there is a major increase, from zero to 3%, which I don’t see happening, I don’t really believe that increases of rates will have a major impact on U.S. economic activity. Number two, because it will signal the end of the loosening stage, you will see continued strength in the U.S. dollar. Some emerging market currencies are still overvalued because people were searching for yield. It will be better for corporate earnings long term, but you may see short-term selling as dollars that flooded into emerging markets will go back home to the U.S. where people see higher yields.
Q:Tells us about Kering.
A: This is the owner of very strong fashion brands, including Gucci, Balenciaga, Bottega Veneta. It is well managed and fast-growing, and they control Puma (PUM), a turnaround story, albeit a small part of the business. The company has transformed itself from a conglomerate to one focused on luxury brands, and they have good exposure to the emerging world and still do well in the developed world. It trades at about 14 times next year’s earnings, with very good growth prospects, brands and it is soundly managed. Operating profitability – operating income as a percentage of sales – is about 18%. The sector has been hit because of the slowdown in emerging markets, which I think is cyclical
Q: What are your thoughts on Brazil?
A: Brazil has serious structural issues that will make it difficult for companies to increase their earnings stream. We would invest at the right price, but companies we would want to own still look too expensive. At the right price, we would be interested in Lojas Americanas (LAME3, Financial), a retailer. Lojas trades at roughly 30 times 2014 earnings and 21 times next year’s earnings. That is not inexpensive, and this is a country with micro- and macroeconomic challenges they have not come close to addressing. Brazil doesn’t have strong mineral prices to hide behind anymore.
Q: What are you worried about?
A: In these unstable times, if there is an economic shock, to withstand it and be offensive, as opposed to defensive, you have to watch balance sheets and cash flow. You have to make sure you are not exposed to operational and financial risk at the same time. Operationally geared businesses have fixed costs like a big smelter – volumes drop, but you can’t shut it down – versus a business where you can cut purchases, inventory or people. As long as the company has a lot of variable costs and not a lot of fixed assets, you can handle a downturn better. But if it also is operationally geared, that can spell trouble.
Q: Should South Korea be an emerging market?
A: When key companies act like relatively immature businesses, yes. Hyundai Motor (005380.Korea) spent $10 billion [on] property in central Seoul. The stock dropped 10%, and shareholders were not happy. Poor governance can destroy value.
Q: What are your favorite companies today?
A: We have exposure to European financials, a beat-up sector. BNP Paribas (BNPQY) and Credit SuisseGroup (CS and CSGN.Switzerland) were under the regulatory scalpel but survived. And global brands like Daimler, Diageo, Richemont, Kering; they are exposed to structural growth and are selling – on an enterprise value to cash flow basis – at low prices.
Q:What is happening in Japan? It has gone off everyone’s radar again.
A: We were significantly overweight, we trimmed back significantly, and it is down 4% since the beginning of the year. Japan is one of the few markets that is down in the developed West. What we have seen are good things happening, especially the moves by the government employee pension fund, corporate governance. There are some good opportunities there. As the yen continues to weaken, it is good for corporate Japan’s earnings.
Q: What do you own?
A: Honda Motor (HMC and 7267.Japan) is our largest holding in Japan, but we own Toyota Motor (TM and 7203.Japan), Daiwa Securities Group (8601.Japan) and Olympus (7733.Japan).
Q: Are we in for another downturn in Europe?
A: I don’t think so – I think we are bouncing at the bottom. The UK, Ireland, Spain, Scandinavia are doing OK. Germany is hanging in there. France and Italy need structural reform to free up their labor markets so people are not afraid to invest, expand and hire. All the low interest rates in the world are not going to hire [people in] Italy and France. You need flexible labor markets to grow again. You need to deregulate economies. Europe needs to get its head out of the sand. And the U.S. should be careful not to follow the European model or we will end up like them.
Q: Thanks, David.
http://blogs.barrons.com/emergingmarketsdaily/2014/10/07/12-stock-picks-from-oakmarks-david-herro/
David Hero's Interview with Baron Done By Dimitra DeFotis
