Value investing comes in lots of different flavors. Whether you’re intent on finding Graham’s now elusive net-nets, follow Warren Buffett’s advice to invest in a ‘wonderful company at a fair price,’ or just look for companies with a low valuation and no red flags, what ties value investors together is a bottom-up approach that focuses on current fundamentals instead of trying to out-predict the market.
Matt Fine, who took over as sole Lead Portfolio Manager of Third Avenue International Value Fund earlier this year, has the same commitment deep value, fundamental investing, but with a nearly wide open mandate and just four people dedicated to the International Value Fund, it’s macro-economic distress that often points him in the right direction.
Carlson Capital's Double Black Diamond Fund posted a return of 3.3% net of fees in August, according to a copy of the fund's letter, which ValueWalk has been able to review. Q3 2021 hedge fund letters, conferences and more Following this performance, for the year to the end of August, the fund has produced a Read More
“We don’t have to go anywhere and we don’t have to do anything. It’s purely driven by the opportunity set and a specific allocation of the capital. It’s not at all driven by top-down macroeconomic predictions,” says Matt Fine . “The question of how we narrow down that universe is of course a very big question, and essential to what we do. How do we boil the ocean? In, short we go looking for crises”, Fine said in an interview with ValueWalk.
Matt Fine: Investing in the low point of cyclic businesses
The years after the global financial crisis may have been ideal for value investors, but Matt Fine isn’t necessarily talking about such large scale events. To explain the process, he gives the example of the fund’s recent investment in Petroleum Geo-Services ASA (ADR) (OTCMKTS:PGSVY) (STO:PGSO), an oil and gas services company that specializes in seismic.
“The environment in the industry today is shockingly similar to the early 2000s… when shareholders of major E&P [exploration and production] companies were putting a lot of pressure on these companies to produce more free cash flow and to be more careful with how they spend their cash. The implication of that was reduced demand for services, particularly those of finding new reserves,” says Matt Fine. “You can literally take the headlines from the early 2000s and confuse them for today’s headlines.”
Last time around, Matt Fine realized that the pressure on E&P companies to reduce capex meant that oil and gas services companies were going to have lower revenues to see how the various players stacked up against each other.
“What you hope to find when you go down that path is good companies and bad companies, company A with a great balance sheet and company B with a terrible balance sheet, and an industry structure where there are companies that are much more likely to go out of business, or feel much more pain, and companies that have a very high probability of being able to ride it out for a long period of time,” says Fine.
Last time around Matt Fine invested in CGG (Compagnie Générale de Géophysique) because it was the best capitalized company in the industry, but this time he says that it’s Petroleum Geo Services (PGS), which went through a recapitalization fairly recently, leaving it with the strongest balance sheet in the sector and a modern, low cost fleet. As other players have to take vessels out of service to weather the storm of falling demand, PGS will be able to take a bigger chunk of a smaller pie.
But eventually the E&P companies will need to start spending again: you can only pump oil from the same wells for so long. And when that happens, Matt Fine’s plan is to be invested in what is then the largest player in a rebounding market. Sometimes that means holding on to a company for a relatively long time, the fund’s historical average is about six years, but it’s the combination of sector or regional weakness along with fundamental strength that lies behind Matt Fine’s approach.
“We want to be very sure about the survivability of the company in question, that’s absolutely paramount. One of the uncertain aspects is the timing of the recovery, and you need to be sure your company is still going to be around otherwise all of this is moot.”
Matt Fine: Differentiating firms by the industry’s cost structure
Another example is the copper industry, where prices have been falling for the last few years largely due to falling Chinese demand and are now hovering just above $3 per pound. But Matt Fine says that a lot of production capacity is uneconomic at that price and suppliers will have trouble meeting demand, which should eventually push prices back up. That observation alone might be enough for someone to want to be exposed to copper, but for Matt Fine it’s just the first step.
Low cost producers are still making a decent profit, even at $3 per pound, but more importantly they offer a margin of safety in case the price of copper drops even further. Even though Fine doesn’t expect that to happen, he’s still working a margin of safety into his calculations. Then, among the low cost producers, fin the ones that have solid assets and healthy balance sheets so that they will be around to benefit from appreciating copper prices when and if they come. To meet those criteria, he came up with Capstone Mining Corp (TSE:CS) (OTCMKTS:CSFFF).
“If copper stays at $3 a pound for a protracted time period, we’re earning today about 12% after-tax free cash flow yield in Capstone share price today,” says Matt Fine. “Even if nothing improves, we’re gonna earn about a 12% free cash flow and to me that feels like a very good proposition.”
Matt Fine: Finding strong companies in weak countries
Matt Fine’s approach – find a crisis, look for the point of maximum pain, and then find a company that you’re sure will come out the other side – can work just as well when there is regional weakness as it does for industry distress.
“It’s hard to think of a company that would have a worse description than manufacturing Greek cement in the midst of the European sovereign crisis. It’s sensitive to public spending, it’s a long-term fixed investment, and it’s headquartered in Greece,” says Matt Fine.
Nonetheless, that’s where he ended up when he invested in Titan Cement Co Ord (OTCMKTS:TITCF) a few years ago. The crisis itself couldn’t be missed, as analysts wondered whether the eurozone would come through in one piece, and then if you’re looking for the most severely affected economy Greece is again a clear choice. But the headline description of Titan, while literally true, is misleading. As a regional player with successful businesses in Egypt, Turkey, and elsewhere, it’s not completely exposed to the Greek economy. It also has a valuable Miami business, what Fine calls one of the most attractive cement markets on the planet, that was still being undervalued because Miami had not yet recovered from the housing crisis.
Add in the fact that Titan Cement Co Ord (OTCMKTS:TITCF) had a strong balance sheet and was still basically family run by people who deeply about shareholder value because it’s literally their money too, and Matt Fine was sold. He was able to find a company that he would have liked with or without the surrounding pessimism, but it was the crisis that gave him such a good entry point into a strong business.
Matt Fine: Advice for retail investors
For individual investors managing their own portfolios who might want to try this crisis-oriented approach to value investing themselves, Fine has two parting bits of advice that you should take to heart.
“Be long-term. I’ve been in this industry fifteen years, and every year that goes by I develop an appreciation for how extraordinarily difficult it is to predict the short-term,” says Matt Fine. There are no guarantees than any deal will work out, but the structural analysis that leads Matt Fine to make investments (differentiating strong and weak companies, looking at an industry’s cost structure) doesn’t even mean anything in the short-term.
“Think about the downside first,” he concludes. “Amazingly, I don’t think that comes naturally to a lot of people.”