One of favorite investors at The Acquirer’s Multiple – Stock Screener is Alexander Roepers.
Roepers is the Chief Investment Officer of Atlantic Investment Management, a global equity value-investing firm he founded in 1988. Roepers applies a differentiated constructive shareholder activist (CSA) investment approach to unlock incremental value in high-quality, undervalued companies in the consumer, industrials and businesses services sectors. Atlantic’s highly experienced investment team has successfully influenced change at many leading companies over the past 28 years in the U.S., Europe and Japan.
As of December 2016, Atlantic Investment Management had $809.38 million in assets under management (AUM).
One of our favorite Roepers interviews was one he did with Value Investor Insight in 2007. What particularly struck a chord was his approach to picking stocks – We favor companies with transparent businesses that we can understand fairly quickly and those that have large and recurring maintenance, repair and overhaul revenues from an installed base, such as elevator companies or aerospace-parts firms. It’s a must read interview for all investors.
Here’s an excerpt from that interview:
Since you started out in the business you’ve focused on quite a narrow investment universe. Why?
Alexander Roepers: I realized early on from watching people like Warren Buffett and some of the early private-equity players that if I was going to stand out, I needed to concentrate on my highest-conviction ideas, in a well-defined set of companies that I knew very well. As a result, I limit my universe inside and outside the U.S. in a variety of ways. I want liquidity, so I don’t look at anything below $1 billion in market cap. I want to have direct contact with management and to be a top-ten shareholder in my core holdings, so anything above a $20 billion market cap is out.
Because five or six unique holdings make up 60-70% of each of my portfolios, I also exclude companies with idiosyncratic risk profiles that I consider unacceptable in such a concentrated portfolio. That means I exclude high-tech and biotech companies with technological-obsolescence risk, tobacco or pharmaceutical companies with big product-liability risks, utilities and other regulated companies where the government can change the rules of the game, and companies that lack sufficient transparency, like banks, brokerages and insurance companies.
Then we boil it down further into potential “core” longs and “other” longs. Core longs are those in which we can own 2-7% of the company and have a close, constructive relationship with management. Overall, the potential universe of core holdings has around 170 companies in the U.S. and about 180 outside the U.S. These are the stocks that drive our performance – we’ve made our record by finding our share of big winners among these core longs while avoiding almost any losers. Our most-concentrated U.S. fund, which holds only five or six stocks, has had only one losing investment since we started it more than 14 years ago.
Describe the types of companies that do make the cut?
AR: They’re typically industrial products and services companies, like defense suppliers, packaging firms and diversified industrials. We favor companies with transparent businesses that we can understand fairly quickly and those that have large and recurring maintenance, repair and overhaul revenues from an installed base, such as elevator companies or aerospace-parts firms.
We require strong balance sheets and a long record of profitability, so we’re not usually investing in classic turnarounds. The stocks are cheap because they’ve hit a speed bump of some kind – from a messed-up factory changeover, an unusual competitive pricing issue or maybe some kind of commodity pricing pressure – but we think we can understand the problems and anticipate that the issues are solvable or going away.
We also put a lot of emphasis on the sustainability and predictability of the business. Our companies tend to be in industries that have consolidated, with only two, three or four leading players. For example, we’ve owned Ball Corporation [BLL], the packaging company, as a core long four times over the past 14 years. Ball’s customers require a global scale that only a very few companies can have and, if a competitor doesn’t have it, it’s likely to go away. We can’t take that type of risk in a concentrated portfolio.
How do you generate specific ideas?
AR: With a narrowly defined universe, the ideas typically just fall in our lap. We have what we call a signal system, which tracks hundreds of companies against valuation metrics and historical trading levels. Our primary input is to make sure we have all the right companies in the system and then set the triggers for each company at which we think it deserves a closer look. So if a Constellation Brands [STZ], for example, falls 10% in a day as it did last month, we’ll put someone on it right away. I’ve got an analyst reviewing the company as we speak.
I sit down three or four times a week with all of our analysts and go through the system and make to-do lists. It’s my favorite and most productive time and it’s a disciplined way to ensure we don’t miss things.
I’ll give you a good example of one of our typical investments, in Sonoco Products [SON]. Sonoco is a 108-year-old company in South Carolina that makes industrial and consumer packaging, such as composite-paper cans for Pringles or flexible packaging for Gillette shavers or Oreo cookies. I had watched the company for 10 years and the fabric of the business is just what we look for: it has never lost money, has paid quarterly dividends since 1925, has 250 facilities around the world and has no major technological-obsolescence risk. The problem was that it was never cheap enough, until about four years ago when they had problems in some of their more cyclical businesses and had pension fund losses that hit earnings. The stock fell by a third, the dividend yield got to 4% and we started buying around $20.
It may be a boring business, but they were well-positioned, continued to execute very well and the temporary problems got better. On top of that, with some fairly strong urging on our part, they started last year buying back shares in volume with excess cash flow. As the share price recently started hitting all-time highs, we sold almost all of our position. [Note: Sonoco shares currently trade around $37.]
On what valuation metrics do you focus?
AR: We want to see at least a 10% free-cash-flow yield and a 6x or less multiple of enterprise value to next year’s earnings before interest, taxes, depreciation and amortization [EBITDA]. For enterprise value we use the current market value plus the estimated net debt 12 months out.
Most of the companies in our universe generally live within a range of 6x to 8x EBITDA. The idea is to identify companies having some earnings or other trouble that leave them trading at the low end of the valuation range. If our analysis is right that the difficulties are temporary, we get two boosts: from earnings recovering and from the market reacting to the earnings recovering and moving the multiple to the higher end of the range. We believe that dynamic gives all our core positions a very high probability of at least a 50% return within two years.
At the end of the day we’re trying to buy companies