Outfitters, Tesco and Newmont.
In the period, new additions—all at floors and at least 20% below our FMV estimates— include the companies detailed below.
With the Nikkei having corrected by 14% during 2014, many Japanese equities look interesting. One Japanese stock we recently purchased is Mitsubishi UFJ Financial Group (NYSE:MTU).Mostly known for its Bank of Tokyo brand (Japan’s largest bank), MUFGcontinues to expand around the world with acquisitions in Thailand, the U.S., and Hong Kong. In the U.S., MUFG now ranks within the top 15 financial institutions (its main brand is Union Bank) based on deposits and aims to be a top-10 U.S. financial institution based on profitability and scale.
Hitachi (OTCMKTS:HTHIY) is a large industrial conglomerate concentrating on sectors related to “socialinnovation” including information & telecommunication systems, power systems, social infrastructure & industrial systems, automotive systems, digital media & consumer products and financial services. Despite benefiting from a weakening Yen and weighted toward higher-growth industrial segments, Hitachi trades at a discount to its global peers.
Honda shares have fallen over 20% since reporting disappointing 2013 results which saw3.56 million units sold against expectations of over 3.6 million units. Honda also experienced higher costs related to vehicle recalls. While there is nothing on the immediate horizon to excite investors, as no new full-scale changes to its lineup are expected until the new Honda Civic, the shares now trade at book value, a valuation level seen only a handful of times over the last twenty years, and at a reasonable discount to all of its trading metrics over the last 10 years. We are optimistic about Honda’s prospects over the next couple of years as recall issues are tackled, capital expenditures reined in, and new products are expected to be launched.
First Quantum Minerals, a Toronto listed company, is a global base metals miner, producingprimarily copper and nickel, with operations in Zambia, Australia, Finland and Peru. In 2013, the company acquired Inmet Mining for its Cobre Panama project, which should create significant shareholder value as the mine ramps to full production levels over the next few years.
German financial services firm Allianz has been in the news recently due to a high profile dispute between current and former executives at its PIMCO subsidiary. The public mudslinging has provided an opportunity to purchase Allianz shares at 1.1x tangible book value while the sector average is closer to 1.8x. Allianz’s Property & Casualty unit is performing well and a growing cash hoard could lead to share buybacks and/or a higher dividend.
U.K.-based Meggitt designs, manufactures and maintains components and sub-systems for civilian and military aircraft. On the civilian side, the outlook is rosy; record backlogs at Boeing and Airbus are driving original equipment orders and aftermarket demand should pick up from high current aircraft utilization. Cuts in U.S. defense (approximately 25% of revenue) are being offset by growing Middle East and Asian military budgets.
We reinitiated a position in networking company Juniper (NYSE:JNPR). Juniper shares were sold at around current levels in January as the stock had run up to our FMV estimate. After we sold, a well-known hedge fund announced it had acquired a stake and presented a plan to cut costs
and boost revenues. We reviewed their plan and concluded, if it were fully implemented,
Juniper’s FMV could jump significantly from our original estimate. After signs emerged that Juniper’s board was willing to discuss the initiatives we repurchased the shares.
Xerox, whose business has transformed from a document provider to an outsourcing serviceprovider, continues its ongoing shift to higher margin revenue which should deliver a higher valuation multiple.
Price matching strategies and a revamped online experience have helped Best Buy (NYSE:BBY) accelerate revenue growth while the company has successfully managed its operating costs. We see this trend continuing while at the same time the overall culture of the firm continues to improve.
Though the Canadian expansion continues to drag Target (NYSE:TGT)’s overall profitability lower, we actually have a positive view of the ultimate outcome of Target’s options. Either the company, under the leadership of a new CEO, is successful with Canada or it’s not and decides to write-off the venture, but earnings accretion should be material whichever option materializes.
With recent shareholder friendly actions including CEO and chairman separation, new CFO, new COO and new brand presidents, Abercrombie & Fitch (NYSE:ANF)’s governance quality has materially improved. With the brand still scoring well with consumers and the company continuing to earn trough margins, the discount between our estimate of FMV and the current stock price offers a margin of safety.
Income Holdings
The 10-year government bond in the U.S. has stabilized at about 2.6% recently. However, we foresee higher rates ahead. High-yield corporate bond rates now yield about 5.4%, and trade near their lows. Our holdings have an average current annual yield (income we receive as a percent of current market value) just below 7%—a bit lower than normal due to our cash holdings as a result of sales over the last number of quarters and finding suitable replacements has been more difficult than usual.
We continue to hold a number of undervalued income positions, a few trading well below par, but with value based on asset coverage which, we believe, justifies much higher prices. And we continue to collect outsized interest income on these positions due to the depressed prices.
We look for income opportunities where interest and asset coverage are well above average (to mitigate potential risk of permanent loss) and the return relatively high (both from current income and the potential for capital gain). However, we have been holding more cash than usual as low rates, particularly in high yield securities, have created a dearth of attractive opportunities. We will continue to explore for opportunities, both via screening and our network of contacts, and patiently await better risk/reward parameters.
We continue to opportunistically add positions and recently added to our list of undervalued Canadian publicly traded REITs. Our REIT basket now yields about 7% with an average 7.25% implied cap rate—undervalued relative to the private markets. During the quarter we added Quebec-based diversified REIT, Cominar. We view the 93% tenant occupied portfolio as well managed and conservatively capitalized. We are encouraged with management’s ongoing geographic diversification initiatives which we believe will help the units appreciate closer to our estimate of FMV while we collect the REIT’s current 7% distribution.
The 7.75% convertible bonds of wireless service operator, Telecommunications Systems (TSYS), were purchased during the quarter. In addition to being the global leader in 9-1-1 call routing for wireless and VoIP network operators, TSYS is also a leader in messaging and wireless location-based services, and provider to government agencies of satellite-based solutions (ground terminals, field support, bandwidth access). With cash flows at cyclical lows we see material upside in pre-tax profits which should translate into higher bond prices. However, even if margins fail to normalize, we are afforded an adequate margin of safety as the company’s debt is covered by its monetizable intellectual property by about 200% in our view.
We sold our Pitney Bowes preferred shares after the price lifted and yield commensurately fell to where we were concerned that the risk/reward ratio was no longer favourable. And, we eliminated our NII Cap bonds after they had a decent recovery even though the company continues to disappoint with its results. High-yielding Renegade shares were sold too, as the shares rose when the company announced it was to be acquired.
Of note, regarding our top income holdings: Specialty Foods, now an equity holding of a private company, held only in our taxable income accounts, is expected to return capital to us later this year (see the reference under All Cap holdings above); IBI Group’s convertible debentures should see their value bolstered by the announced restructuring of its holdings; Advantex Marketing debentures should benefit from its diversification of additional customers;
Retrocom REIT’s price still doesn’t reflect the underlying net asset value which is growingfrom optimization of its real estate portfolio; JC Penney bonds, due late next year, have ample liquidity coverage and its owned real estate provides comfort too; Ruby Tuesday’s operations have begun to recover while its bonds are well covered by underlying real estate; Brookfield Real Estate Services was able to bump its dividend because of its steady royalties based on theincreasing number of real estate agents in its network; Student Transportation shares trade at slight undervalution but could easily be the subject of a consolidation with a larger entity; Dundee REIT has a stable and diverse stream of income; Southern Pacific Resources debentures continue to trade below our estimate of fair value even as the company finally shows signs of recovery.
Stock Picking and Wall Climbing
Our performance is improving and we believe that many of our holdings are prospective for growth over the next year. We have been increasing our weighting in larger cap companies.
But it’s our Canadian smaller caps, which have been doing better, that have the potential to
reward us significantly and in short order. We are, first and foremost, value investors and are supported by many studies that show that over extended periods value stocks outperform by a large amount. We also have developed proprietary technology to forecast economic recessions and the potential for overall market declines, and to help with the valuations of our holdings and opportunistically time the purchases and sales of these holdings. We believe these tools should meaningfully add to performance.
Bottom line, we are patient investors, unlike the recently criticized high-frequency kind. We strive to buy mispriced securities to give us a margin of safety and be able to endure corrections and await their recoveries. At the end of the day, it’s the bottom-up stock picking that dictates most of our returns. And climbing walls carefully.
Herbert Abramson and
Randall Abramson, CFA
May 26, 2014
All investments involve risk, including loss of principal. This document provides information not intended to meet objectives or suitability requirements of any specific individual. This information is provided for educational or discussion purposes only and should not be considered investment advice or a solicitation to buy or sell securities. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. This report is not to be construed as an offer, solicitation or recommendation to buy or sell any of the securities herein named. We may or may not continue to hold any of the securities mentioned. Trapeze Asset Management Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities named in this report. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. E.&O.E.
