David Herro (Trades, Portfolio), Oakmark portfolio manager and Morningstar’s international fund manager of the year 2016, disclosed in his shareholder letter this week that he purchased Southwest Airlines (LUV, Financial) and Reckitt Benckiser (XSWX:RB, Financial) in the second quarter.
Herro has until Aug. 15 to provide details of his second-quarter buys and sales but reported the trades and this thoughts about them early for shareholders of his $2.6 billion Oakmark Global Fund. The two fresh positions were the smallest in the portfolio, with Southwest Airlines worth 0.5% of net assets and Reckitt Benckiser Group worth 0.4% at the end of the quarter. Herro, who oversees several international funds for $70 billion asset manager Oakmark, also exited his position in Koninklijke Philips (PHG, Financial) "due to its price" and added to a stake in Liberty Broadband (LBRDA, Financial).
The Oakmark Global Fund contains both U.S. and non-U.S. stocks of all market caps that trade at discounts to their true economic value, display growth potential and have shareholder-focused managers. Investments in the portfolio are skewed toward the U.S., with 46.2% of equity allocated to the country. In his first-quarter letter, Herro compared the U.S. allocation, then 45%, to the 60% U.S. weighting in the MSCI World Index, saying it reflected their view that “international markets currently offer better opportunities.”
“We never target a particular country (or industry) weight,” Herro wrote. “Instead, our weightings are the result of our efforts to populate the Fund with our best ideas, while also seeking appropriate diversification.”
In March, he sounded more bullish on the U.S., saying that the economy was entering an “accelerator phase,” characterized by top-line growth and capital expenditures.
“Earlier, earnings were driven by stock buybacksand cost-cutting,” he told InvestmentNews. “Now we're seeing real economic growth, rather than manufactured earnings growth.”
Herro looks for situations in which value and price have not moved in the same direction and approaches public stock selection employing the thinking of a private equity investor.
“… like private equity, we value businesses based on our estimate of their intrinsic value, buy them at a substantial discount and then later sell when they are fully valued. Unlike private equity, however, we don’t mark our portfolio companies based on where peers trade or our estimate of the long-term fundamental outlook of the business – we mark according to current public stock prices no matter how different than an arguably better representation of fair value,” he wrote in his shareholder letter.
The strategy has served him well, leading to a 10.3% annual compound return since the fund’s inception versus a 4.8% return in the MSCI World Index. Oakmark was founded in 1991, and Herro joined in 1992. The Oakmark Global Fund launched in 1999.
Stocks from the consumer discretionary sector occupy the most portfolio space in the fund at 28.5%, followed by financials at 26.5%. Herro has as his top positions: Daimler (XTER:DAI, Financial), Lloyds Banking Group (LYG, Financial) and Allianz.
The new buys
Southwest Airlines Co.
Shares of Southwest Airlines declined 20% year to date, to trade around $53.30 Friday afternoon.
Herro commented on the stock in his second-quarter shareholder letter:
“LUV is the largest and most profitable airline in the U.S. with 24% total domestic market share and 66% share in its top 100 city pairs. LUV has been profitable for 45 consecutive years, despite competing in an industry that has been littered with bankruptcies. The company has been on Fortune’s list of “World’s Most Admired Companies” every year for nearly a quarter of a century. LUV’s brand recognition and strong customer loyalty stem from its outstanding service, efficient operations and refusal to nickel-and-dime on fees. The company’s above-average operating margins are enabled by a lower cost model compared to network carriers. LUV has a strong balance sheet and returns most of its free cash flow to shareholders through significant share repurchases and dividends. Despite these positive characteristics, we were able to purchase the shares at only a mid-single digit multiple of normal operating income due to short-term pressure from the run-up in fuel prices and the suspension of marketing following the recent passenger fatality.”
Reckitt Benckiser
Shares of Reckitt Benckiser fell 8% year to date, to trade around $83.33 each Friday afternoon.
Herro commented on the stock in his second-quarter shareholder letter:
"RB is a leading global consumer products company with $15 billion of sales in 2017 and strong brands in health, infant nutrition, home care and hygiene. RB has successfully expanded its presence in high-value health products categories and increased its operating profitability via premiumization and excellent cost discipline. RB’s historical best-in-class performance can in part be attributed to its significant insider ownership: the CEO and CFO are required to own shares worth more than 40 times and 20 times their salaries, respectively. RB’s share price recently declined due to transitory factors as well as weakness in its relatively small home care division. Management is restructuring the home care division to provide greater accountability and may sell the division to an owner who can extract greater operational synergies. Moreover, many of the transitory factors affecting the share price are expected to disappear in fiscal year 2019. Therefore, in our view, the current share price does not reflect the company’s strong underlying value or its potential for increased profits, so we initiated a position in RB during the past quarter."
See David Herro (Trades, Portfolio)'s portfolio here.
