Saturday, December 3, 2011
This is a 1.5-hour Columbia Business School lecture by Tom Russo from Spring 2009 (unconfirmed, my estimate).
Staying the course is important and hard to do in bear markets: Buffett visited his Stanford bschool class in 1980 and gave the following principles.
(1) The IRS does not tax unrealized gains so try to find things you can hold forever, the long term matters
(2) In a lifetime, you might have 20 great ideas so buy and hold
(3) Define your circle of competence (for Russo, consumer product and media companies)
(4) Choose management well. There is no deal to be made with corrupt people. It is an agency cost.
Long-term holding/stay the course has worked for his partnership. In 1999, they were down while the markets were up 27%. The story at time was that the internet will change everything, including grocery shopping and media. Traditional businesses were sold off, and the investors were bidding up the glamorous internet. Then in 2000, the market was down, while they were up 17%.
Also thinking long-term, stocks do reflect underlying cashflows. Since they hold a lot of basic consumer companies, these cashflows have been generally stable and growing over time. Also brand owners are able to match inflation well.
In addition, consumer companies are very shareholder-friendly: less agency costs. They do keep shareholders in mind when making capital allocations. He likes family-controlled businesses (unlike many who are wary of it) provided that, upon inspection, there is no self-dealing. Gives Adelphia vs. Comcast example. The families do not need to get bigger, and are less likely to do accounting manipulations.
Since they invest in global companies they also get some currency tailwinds. While admittedly not statistically significant, their experience has been that during years in which the US markets are weak, the US dollar has been weak. So an investor holding 40-65% international portfolio gets some boost from currency gains. For example, in 2002 they ere barely down (with 6% gain in currency) vs. S%P down ~25%.
Now the downside, they hold PM: they expect 80c decline EPS decline on $3.40 solely due to currency. Also holds other brand companies, Nestle, SAB, Heineken, Pernod Ricard, and likes the products, as it makes the research more fun.
There are few new ideas. A professor had an investment: an undervalued champagne company with no earnings, lots of inventory and acreage. Then at Sequoia Fund, he researched Brown Forman. BF then expanded into the flavored alcohol/coolers business. The stock shot up on the acquisition, but then the business fell off the cliff and the stock tanked. The shares plunged, and Sequoia researched them. So he's been investing in alcohol for a while. In 1987 the partnership was up 35% vs. market down 7% largely because of an alcohol company they had (Beefeater-brand owner) that was acquired. Great single brand companies do not survive for too long on their own: usually no distribution clout. Overtime they owned Corby, BF, Diageo, Allied Domeq. The point is you can figure out things, you will have multiple times to participate in the industry you know.
He also invested in newspapers, straight from Berkshire, so he started following them ("no new ideas"). Now that industry has hit a wall.
Now owns global liquor businesses: huge reinvestment opportunities. The brands have very small shares in the most interesting markets (China, India). So the cash flows from the mature business go to build in the new markets. So the real return to value investors is not only from the discount but also growth because of good reinvestment prospects. The market sometimes gets it wrong when the emerging market investments create short-term financial reporting disappointments. But these are often fixed cost investments, then they scale very well. So "reported" profits may be understated. This is true across many businesses they have with EM operations. They first bought BF in 1989, doing at 5 mm cases of Jack Daniels, mostly in the US. The multiple was low. The entire return since that time has come from growth abroad. They do 10 mm cases now. The shares have compounded at 15% per year. It has never been very exciting, largely a forgotten company. And now the future prospects are even higher as they hit the breakevens on the various international markets. Same with Pernod.
Pernod case: management has a good record. They started with a small cashflowing business in France, then started acquiring abroad. Irish Distillers, then Seagrams. With Seagrams, they got a good China business, Chivas and Martell. Then the 1997/98 crisis happened in Asia, and many Western businesses shut down. Back then, the crisis led currency collapses adn lack of buying power. Importers found it very hard to import, so foreign companies left. Pernod did not leave, and ended up "owning" the market once the recovery came. Many portfolio companies have the ability to endure losses like these. Then Pernod bought Allied Domecq and became a global. The business is decentralized. They own their distribution channels whenever possible. Now Pernod bought Absolut, the shares tanked due to the leverage, so Russo is buying Pernod. Pernod understands branding: in China, they just increased Absolut prices 50%, it was not aspirational enough. They will quickly make up the volume with dollars margin. Also very good at localizing products to taste or complimentary products. Price is suppressed: fear of emerging markets, fear of downtrading in OECD, the Absolut acquisition put 5 bn euros of debt/future credit access, share repurchases have stopped and the price paid for the acquisition. Position sized at about 5%, have 25% in alcohol. Across the board at single P/Es but all have good prospects for growth.
Q: Formula for financials' assessment?
A: the core business of Pernod is strong, Absolut is transformative in our view. We cannot put a precise number on that.
Q: Do you have an intrisic value for Pernod?
Q: On currencies/EMs in the turmoil?
A: Currencies and foreign markets are unknowable. Met with PM CEO, and he thinks the crisis is a US crisis. So (EM example) Russia, will be better vs. 1998: stronger country, local expenses, local production, several pricepoints. Russo has exposure in E Europe: the currencies look wobbly but no view on the future.
Q: How do you assess total addressable market in EM?
A: You will know it when you see it, no real approach. You know an elephant when you see it. He's investing in the conversion of rising GDP to branded consumer products. Often this displaces an indigenous product, like baiju in China, with a global brand. In India, beer is at 0.7L per person vs. 17 in china and 100+ in US. PG and disposable diapers: started at 3 mm cases few years ago, 2008 70 mm cases. But this is 2 cents per capita vs. few dollars/capita in the US. PG has tiered the product. New diaper plants come pre-assembled and can put it up in a week.
Q:How do you measure management alignment of interest with shareholders?
A: Have to pick the family right. No litmus tests, spend time with the family.
Q: Direct EM investments?
A: Often have the multinationals that deal in EMs, so they get more control over local management, more audit certainty, etc. Had a direct investment in a Slovakian chocolate company. The information flow burdens and the risk were too high to bear. Also the valuations have been much higher in EM for locally listed subsidiaries (ie Unilever Hindustan).
Q: Sell discipline
A: Now more prepared to take a critical look after 2008. But now harder to want business at lower prices.
A: Good discussion of how Richemont expanded in Russia (carefully, no partners, spent more for real estate they control).
A: Can't see Dell's future so no investment there. Ultimate commodity, and threatened by technology. Can't model it after consumer company process.
A: Sarbox is helping them with more controlled entities. Comfort varies from family to family, it is qualitative. With Berkshire's new independent board, succession is centerstage, and this is helping them as outside holders.
Q: Brand impairments?
A: Try not to get involved with impaired brands. Absolut might have been underutilized, and Pernod has the capacity to revitalize. Cadbury Schweppes: their great growth came when Mars went to sleep. Mars is now back, bought Wrigley, and this might hurt C-S company.
Q: Sell at what multiples?
A: At very high multiples, he'd sell no matter what; at high multiples, they reduce if it is a higher percent of the portfolio (i.e. grown from 5% to 8%). Often uses the cash to add to undervalued/underrepresented positions.
Posted by Barbarian Capital at 01:49