Bill Nygren (Trades, Portfolio) comments on how the prices in the market were a lot different at the start of 2015. Values are now much in favor of traditional value stocks. Ally Financial (ALLY, Financial) is one example. Everyone is concerned about auto loans, but the terms are unchanged from a couple of years ago. Car lenders are focused on lending against depreciating assets. In the fourth quarter 2015 commentary he commented:
Since Ally’s initial public offering in spring 2014, its shares have fallen over 20% while the Standard & Poor's 500 has returned over 15%. Over this period, some investors have grown concerned that the business is at a cyclical peak, as U.S. auto sales are near record levels, and credit losses are below long-term averages; as a result, some believe Ally’s earnings have nowhere to go but down. We believe cyclical pressures will be offset by continued internal improvements, such as funding cost reductions (as “legacy” liabilities are replaced with lower cost borrowings) and improving their capital structure. With Ally’s stock trading at just 80% of tangible book value, we believe Ally is a compelling addition to the Oakmark Fund.
Ally Financial trades at a market cap of $7.84 billion with a forward P/E of 6.8x and price/book of 0.6x. Amazingly it has $5 billion in cash on its balance sheet but also $73 billion in debt, which would be highly concerning except that this is a financial stock that borrows money cheaply and then makes money by lending it out at a higher rate and capturing the spread.
That's why Nygren's comment about the depreciating assets is key. If the underlying value of assets drops, that tends to create immense problems for financial institutions with this business model. This was exemplified by the 2008 financial crisis. Nygren basically says that, because car loan providers assume the underlying asset is going to depreciate at a high rate, they don't rely on the asset value as much. Instead they focus on creditworthiness of the buyer, a business practice that would arguably have saved us a lot of problems in '08.
Google / Alphabet
Nygren believes the market underestimates how profitable search is. The market also underestimates how resilient search is and how difficult to disrupt. The new reporting structure will allow investors to see how profitable it is. The new reporting structure refers to the holding company Alphabet (GOOG, Financial) (GOOGL, Financial) under which the different companies operate.
Because of the reporting it will be clear that a lot of free cash flow is coming out of Google, which is where traditional search will be, and it is directed at cash flow negative operations like life sciences and the moonshot division. Google has a near $500 billion market cap. Its enterprise value is $436 billion because of a cash-rich balance sheet while producing EBITDA equal to $23 billion. Its EV/EBITDA ratio is 18.75x. The amount of stock that is given out is debatable, but on the flip side key insiders have their interests well aligned with minority shareholders.
Anadarko
Nygren denies he is loading up on oil. GuruFocus allows you to view his allocation by industry. If you do so you will see he has a 6% allocation to energy. Nygren contends that if you look at $30 oil as a normal level, the whole U.S. E&P business goes out of business. Oil needs to be at $60 or global demand for energy can't be served.
If the world GDP growth forecasts are correct, we will use more energy. The largest energy position in the fund is actually Apache Corporation (APA, Financial). Anadarko Petroleum Corporation (APC, Financial), which he talks about, has a market cap of nearly $19 billion and an enterprise value of $34 billion due to $17 billion in debt. It trades at 1.36x book and produces $4 billion in EBITDA. Its EV/EBITDA ratio stands at 8.5x.
Disclosure: Long Google.
