Interview: Xavier Brun on Dealing With Uncertainty

The Head of European Equities from Trea Asset Management shares his ideas about investment strategies, 3D analysis and valuation

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Aug 06, 2019
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Xavier Brun is the head of European equities at Trea Asset Management, a Spanish investment house that manages 4.6 billion euros. He has a doctorate of economic sciences from the University of Barcelona, excellent cum laude, and a master's degree in banking and finance from IDEC at Pompeu Fabra University. He also has 15 years' experience in value investing as an investment manager, analyst, professor and opinion maker.

Brun was very kind to share some details of his investment strategy, his contrary thinking and investment ideas!

Roque: In your last annual fund commentary, you talked about dealing with uncertainty. How do you think investors should think about it when implementing an investment strategy for stocks?

Brun: The uncertainty comes in two ways: valuation and competition.

Valuation. When one analyzes a company, the business model and management, you must know that uncertainty is present. Because one does not know the behavior of customers when buying, or the reaction of suppliers, workers -- human factors that make trying to guess how much and when the earnings per share will be is hard (and impossible) work.

Once you know it, deal with it: Try to see in the medium term the trend of the sector, the company, the business model and once you have it, try to reach a reasonable cash flow or net profit. You will know it is going to be wrong, but at least t is going to be fairly correct. For example, you know that the price of copper should be between $3 and $4 per pound in the long term. With these prices you get the benefit of Antofagasta (LSE:ANTO). But you must know that it is a proxy, since you neither know exactly the price nor exactly the cost. But you know that from a business point of view the price should be between $3 and $4 a pound. After that you get a reasonable normalized cash flow for Antofagasta.

Competition: Will in five years from now the company exist? Can customer needs change? Will the company’s products still sell? With questions, we try to find risks, the origin of risks. Based on my experience, risks usually come from three ways: technology, consumer preferences or regulatory risk. My recommendation here is to ask management about their most difficult decisions, how they solved it, if they learned from mistakes.

Roque: What are your preferred value investing strategies? Why?

Brun: For me, value investing is a way of analyzing, the classification of compounders, GARP, value, quality ... are factors, groupings of companies.

The way I approach the valuation of a company is to determine its normalized profit and multiply it by a price-earnings ratio. Two examples of normalized profit can be one in a cyclical company and a grower company (early stage of growth). In cyclical companies, you look at the profit that the company should have under normal conditions, which means obtaining a reasonable ROCE. For example, BW LPG (

OSL:BWLPG, Financial) has ships, a sector with few barriers to entry. We looked at the average ROCE across the cycle and saw that it was about 7%. From that number we get how much the TCE (freight) should be to achieve that profitability. Once done, you get the benefit and realize that BW LPG quotes a normalized price-earnings ratio of 4x.

In growth companies, you try to see where in the S curves you are. Although there is the most complex investment, because the multiples paid are high. An example is ASML Holding NV (

ASML, Financial) (produces machines to produce chips well below 10 nanometers). As far as the per capita consumption of chips should rise ([due to] IoT, big data, artificial intelligence) you get what should be the average chip per capita and the annualized production. Then you get how many devices you need to produce those chips. Therefore, you get the normalized sales for ASML. It would be better to invest directly in the chip producers (ST Micro, NXP, Infineon, Intel), but we are nobody who can know who will win. However, we feel more comfortable investing in the machines needed to build those chips.

Roque: How do you find investment ideas that fit your criteria?

Brun: In three ways:

1. 3D analysis. What we call 3D. It consists of analyzing the entire value chain and then moving from customer to supplier, and then from customer to supplier again, and so on.

For example, Apple launched the 5S [iPhone] model in September 2013. The market did not like it, and the company dropped sharply. Without assuming growth and with the net cash position, Apple was trading at a price-earnings ratio of 5x. Therefore, we buy.

Then we analyzed mobile phone supplier companies: AMS, Qualcom, Intel, ARM. We saw that Intel (INTC) was trading at a price-earnings of 9x because it was not present in tables or smartphones. False! For every 400 smartphones devices you need one server, where Intel is a leader. So we buy.

And what is stored on servers? Data and media. And how does it come to you? Well, through submarine cables or satellite. Here we analyze Eutelsat, SES, Boskalis, Prysmian, Nexans, and invest in Prysmian and Eutelsat. In the media space, we analyzed Vivendi, which is owned by Bolloré. We analyzed Bolloré (

XPAR:BOL, Financial) and invested in it.

We saw that Bolloré also had ports, so we analyzed all sport companies we could and bought Royal Vopak. Listening to them in quarterly results, they point out how important the LPG terminals were. Therefore, we analyzed then the LPG value chain and invest in BW LPT (transport). Conclusion: We currently own Prysmian (

MIL:PRY, Financial) and BW LPG thanks to Apple. This is the 3D analysis.

2. Reading. We read news, articles and look around observing everything. An example of observation is Huhtamaki Oyj (

BOM:509820, Financial). This company manufactures, among other things, the glasses that companies like Costa Café use to fill cafés. We discovered this after seeing the word Huhtamaki placed on the bottom of a glass. Another example was in 2014 when we invested in Bakkafrost after reading about it in “The Big Read” section in the Financial Times.

2. Talking with other managers. We have attended several value conferences: Madrid, Copenhagen, Trani. All of them strongly recommended. And here we talk with other peers and share ideas.

Roque: What are your preferred valuation methods? Why?

Brun: I prefer to use a multiple (price-earnings ratio), because it is easy to use, meaning it is also easy to keep in the top of your head and because it does not depend on when the flow is going to take place (in the case of the discounted cash flow).

To do so, I look at the normalized net profit, which is actually the free cash flow, and multiply it by a price-earnings ratio. Not a single price-earnings, but I have 4, depending on the category. Category one is companies like Nestle, Danone, with higher price-earnings, and in category four are mining companies, with much smaller price-earnings. Thanks to this, you can now compare Nestlé with a mining company.

Another method, which is less used because it cannot be used for all companies, is the study of Economic Value Added and the capacity of the company to reinvest and allocate capital. This method is not exclusive of the previous one.

And we don't usually do DCF, for two reasons: You have to guess how much you are going to earn and when. Because year one is not the same as year two. This is something that, in reality, the value of the company does not change due to the benefit of year one or two.

Roque: Recently, at the Iberian Value Conference, you recommended an investment in Phillips. Why do you think Phillips will be a long-term compounder?

Brun: Because it has the three characteristics that a compounder has: barriers to entry, growth and good management team.

Barriers to entry: Philips sells medical devices, where the technology has already entered. Therefore, data and historical data is needed, and it is the key. Philips has been obtaining data that can be applied to improve diagnosis and treatment. Achieving that database is not done overnight; you cannot have a software that allows you to have a diagnosis and brings you a treatment if you have no historical data. Moreover, a medical device has trust in it that it is not easy to erase. A doctor asks for a trustworthy company as with this device the doctor saves lives.

Growth: Emerging markets still have to reach the standards of developed countries. For instance, India is far from other emerging markets in terms of beds per person. Currently they have 0.8 beds per person versus 1.6 per person in other countries.

Good management team: The CEO, Frans Van Houten, arrived in 2011 and drastically changed the company. This is not done overnight, but it takes time and the best management.

Roque: The largest holding in your fund is Grifols (GRFS), a Spanish health care company. Can you present your investment thesis?

Brun: Sure. Grifols is a family-owned company (fourth generation), an international producer of blood plasma-based products. It has three segments: Bioscience (about 80% sales), Diagnostics (about 16% sales) and other (hospital and bio suppliers).

Bioscience has high barriers to entry. The result is an oligopolistic market, with only three players (CSL, Takeda and Grifols). The main reason is that you need access to the raw material (Grifols has it secured with plasma centers) and you need to control the whole value chain from plasma center to fractionation plant. That’s because you have to ensure plasma keeps frozen all the time, and you need to have strict safety controls. You also need the plasma centers and fractionation plant to be certified by the Food and Drug Administration.

In this segment, Grifols has fractionation plants with a capacity for 15.2 million liters of plasma. In Clayton (U.S.), it will increase capacity that will allow it to reach 19 million liters.

For each liter, you can generate roughly 80euros in Ebit. That depends on the price and the amount of plasma proteins that you get per liter (the cost of fractionation is practically fixed, so that the operating leverage is high). With this, it obtains about 1,520 million euros.

In diagnosis, it has NAT technology, where it has an 80% market share in blood donation tested.

In 2019, it signed a strategic alliance with Shanghai RAAS in donation segment. However, in the long term it can help them to invest in fractionation plants and hence increase sales in bioscience. It can become the rear door to invest in China. Therefore, the potential is huge for Grifols in the long run.

All in all, and without taking into account the alliance signed with Shanghai RAAS, Grifols will be able to earn approximately 1,400 million euros at a price-earnings ratio of 16x, which gives us a value of 22,400 million euros (about 30% higher than the current market cap). However, there are two tailwinds that can help Grifols to go beyond: Ambar and China.

Ambar is a project with huge potential. It is using albumin (one of the plasma proteins) for Alzehimer’s disease. Summarizing is a treatment for Alzheimer's patients by albumin replacement. It started just 15 years ago and now is in the latest stage of phase II with very encouraging results. It can become a blockbuster for Grifols.

China is the other tailwind. Currently the consumption of Immunoglobin per capita in China is 20 grams per 1,000 people versus 260 in the U.S. or 120 in Germany. If China increases from 20 grams to 80 grams, it is equivalent to another U.S. Therefore, potential here is huge. The agreement with Shanghai RAAS helps you enter the Chinese market, as it has 40 plasma centers.

If we assume that Ambar and China contribute 300 million more net profit, the value will be 4.8 billion (300 x PE 16x) which added to the 22.4 billion gives us equity value of 27.2 billion (approximately 56% margin of safety).

Summarizing, Grifols is an attractive investment, with huge margin of safety, with huge barriers to entry, growth capacity and good management team.

What about risks? No big risks on substitution (neither recombinant nor technological issues).

Roque: One of the hardest decisions in investing is deciding when to sell. What makes you sell an investment?

Brun: It's easy: margin of safety. You sell when the margin of safety decreases. At that time you sell little by little until you have no margin of safety or until you find a better investment with large margin of safety and similar risk.

Roque: Can you share some of the mistakes that you have made over your investment career and what you have learned from them?

Brun: Uff ... There are a few in 15 years.

An example would be:

Purchase of Freeport McMoran. In 2014, the copper mining company bought an oil company. They did it to “to diversify.” At that time, crude oil was at $100 levels and extraction costs at $50 levels. Despite this, we bought 2% of the fund.

Error: No further analysis into the technological risk coming from fracking and the learning curve of the extractors of this crude in the U.S. were having (potential reduction in operating expenditures). Plus we did not go more in depth into the acquisition. We realized management in Freeport were shareholders in Plains and MMR (companies bought by Freeport).

Evolution: We bought 2% at $22 and then it dropped until $8. There we increased our stake to 3%. However, it was not the minimum; the stock halved to $4 in 2016. At this point, we were convinced about the huge potential of the stock. Finally, we sold all of the stake at $16.

Another mistake is about companies that I regret not having bought. I also include those that I sold too soon, for instance:

- Dart Group. We bought the airline travel and logistics company in June 2014 at 180 pence levels and sold it at 300 levels because we did not see the net cash position quarter-on-quarter. In addition, we though this cash was all advance payments from customers.

- Bakkafrost. We bought them at 89NOK levels and sold them at 200NOK. We did not see two things: Salmon prices kept going up and a higher multiple that the market could apply for a full-integrated company (it was currently what Bakkafrost was doing).

Another kind of mistake is stocks that we have not had and that I would have liked [to have bought]:

- Amazon, for instance. In this case, we did not see the huge potential of the networking effect.

Roque: Can you give us a book or article reference that most value investors don't mention but that you find to be particularly enlightening?

Brun: Sure. I suggest two kind of books: one related to financials and another not related. If you read something not related to financials, you get an idea of what is happening in the world without being contaminated by market or market flow. So I strongly recommend reading a lot of everything.

More concrete books I suggest are:

  • Capital Returns (Marathon Management)
  • Quality Investing (Lawrence Cunningham, Torkell Eide and Patrick Hargreaves)
  • One Up on Wall Street (Peter Lynch)
  • Only the Paranoid Survive (Andrew Grove)

Read more here: 

Interview: The Long-Term Vision of Horos Asset Management 

Interview: The True Value of Research 

Interview: Value and Momentum Investing With Valentum Asset Management 

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