Third Avenue Management (Trades, Portfolio), a private investment firm founded by legendary value manager Martin Whitman (Trades, Portfolio), ends its quarter on Oct. 31 and revealed the fourth-quarter trades of its Third Avenue Value Fund in its recent letter.
The leader portfolio manager on the value fund is Chip Rewey. The firm’s philosophy focuses on fundamental, bottom-up research in a hunt for companies with strong capitalization, potential to compound value and shareholder-oriented management. They purchase when the companies trade at a discount to their net asset values.
In the fourth quarter, the fund added to its positions in Amgen (AMGN, Financial) and Shire (SHPG, Financial). It initiated positions in Lennar Corp. (LEN, Financial) and Adient (ADNT, Financial).
Lennar Corp.
Lennar Corp. is a $9.69 billion market cap home builder whose shares closed at $42.56 Friday, down 13% for the year. Its P/B ratio of 1.5 and P/S ratio of 0.9 are both near their five-year lows. In the past five years, it grew earnings 94.3% on average per year, and it pays a 0.37% dividend.
In its quarterly letter, the fund discussed the investment at length:
At our Value Conference, our colleagues on the Real Estate team revisited one of Marty Whitman's quotes from October 1996: "Given Third Avenue's investment criteria, it is more accurate to view the situation as the industry selecting the Fund, rather than Third Avenue choosing the industries in which to invest!' We think this quote superbly describes the opportunity the Value Fund saw in establishing a position in Lennar Corporation common in the quarter, as the shares somewhat inexplicably sold off from nearly $50 at their recent peak and allowed us to establish a position at just over $41 per share.
We have followed Lennar for years as the Real Estate team reviewed the position at our weekly research meetings, and think the investment case has only improved on a fundamental level despite the widening valuation discount in the shares. Lennar meets every tenant of our investment philosophy.
The balance sheet is strong and improving. Net debt to total capital has fallen 5.3% since year-end 2011 to 45.8% as of 3Q16, and net debt to total assets is not challenging at 37%. Much of this improvement is the result of management's soft pivot land strategy, which is reducing the duration of its owned land bank and converting its undervalued balance sheet assets into cash. This balance sheet improvement should continue as Lennar's $400 million redeemable convertible debt matures in November 2016, which should further reduce balance sheet leverage by 200 basis points.
From a compounding point of view, Lennar continues to build value through developing its land bank into saleable housing units, and by monetizing further transaction values through its mortgage origination and title insurance offerings to its home buyers. Notably, we are pleased and supportive of Lennar's offer to acquire WCIC Communities (NYSE:WCIC), a top holding of the Third Avenue Small-Cap Value Fund, as Miami-based Lennar knows WCIC's 100% based Florida assets intimately. Lennar not only sees compelling opportunities to monetize WCIC's over 14,000 homesites, but also synergy opportunities from management and supplier overlap. Further, in our opinion, Lennar negotiated an extremely good price for WCIC, which when considering the value of WCIC's brokerage operation and the hidden value of WCIC's owned coastal tower pads, will likely bring tremendous value as Lennar has a strong balance sheet to move construction of these assets forward.
Lennar's resource conversion outlook is compelling, with management likely to monetize its non-homebuilding investments in FivePoint and Rialto over the next 12-18 months through sales or spin-outs, and then over time, potentially further monetize its Multi-Family and even its Financial Services divisions through sales or partnerships. The value creation of Rialto, its 3rd party asset-light asset management unit with over $7.3 billion in AUM, and of FivePoint, its development and management company with over 40,000 homesites and 20 million square feet of commercial real estate assets in highly coveted California markets are, in our opinion, completely overlooked by the markets from a net asset value perspective, as their income statement impact today belies their true value to Lennar despite being worth more than 25% of the underlying value.
Perhaps Lennar's most exciting aspect is the strength of the investment case and current undervaluation taken without the likely strong tailwind of an improving housing cycle. At our Value Conference we talked about taking advantage of optically poor headlines, and Lennar is another real-time example. We think some of the weakness in Lennar shares in October was due to a weak single family home starts number for September, down 9.5%. The noise of monthly home start numbers do not impact the long-term value we see in Lerman While Lennar's sales and earnings are likely to strengthen as the single family construction cycle continues to recover from an extended cyclical low looking back to 2007, we see this as icing on the cake of our strong investment case. At our cost of just over $41 per share, we see over 25% upside to our estimate of fair trading value of $53, and longer term potential for shares to trade to over $66 per share if the single family cycle gains steam.
Adient Plc
Adient Plc is a $5.28 billion market cap automotive seating company spin-off from Johnson Controls (JCI). Its shares closed Friday at $56.39, up 14.3% since the October spin-off.
We received shares of Adient upon its spin-off from JCI at the end of October. Adient is the market leading provider of automotive seating in North America, Europe and China. It has longstanding relationships with all of the major global Original Equipment Manufacturers as well as growing regionals such as Brilliance, Great Wall Motors, SAIC Motor, Tata Motor, and newer manufacturers such as Tesla. It also has an equity JV with Yanfeng Automotive in China for interior trim systems such as door panels, instrument panels and consoles. The company is geographically diversified, providing some balance with regard to regional economic cycles. Seating, while it sounds fairly mundane, is actually benefiting from enhanced features to increase passenger comfort such as heating/cooling, massage, lumbar support and advanced seat adjustability as well as an increasing shift globally to SUVs, which have higher seating content. For luxury vehicles, the second row bench seat of yesteryear is a thing of the past, having been largely replaced by captain's chairs with all of the passenger comfort amenities. This trend is also moving toward mass market vehicles, increasing the percentage of higher margin seating solutions. Longer term, the opportunity for further enhanced seating exists with conversion of the third row of seats, autonomous driving as well as opportunities to expand into adjacent areas for seating, e.g., commercial vehicles, railway and aircraft seating. Now a standalone entity, Adient has greater ability to focus on growing its core business, along with opportunities for self-help. We believe the company has been under earning as the business has been somewhat capital constrained under its former parent. Also, there are opportunities for margin improvement driven by operating efficiencies and cost reduction initiatives.
Amgen Inc.
Amgen is a $109.9 billion market cap biotech company whose share price closed at $147.55 Friday, down 9.1% year to date. It also has a P/E ratio of 17.36 and P/S ratio of 5.86, as well as a dividend yield of 2.7%.
The value fund held 121,300 shares of Amgen at the end of the third quarter, encompassing 1.85% of the portfolio. It was one of three new medical stocks it acquired that quarter, each of which has declined year to date.
Shire Plc
Share is also a biotech stock ad has a $50.8 billion market cap. Its ADR price closed at $168.65 Friday, after declining 17.7% year to date. The stock has a P/S ratio of 4.8 and carries a dividend yield of 0.48%.
The value fund holds 42,138 shares of Shire, worth 0.73% of the portfolio, which it purchased in the third quarter.
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