The portfolio managers of Artisan Partners emphasized “keeping out of the ditch” enabled them to deliver excellent returns over time.
The firm has $108.2 billion in assets under management (AUM) as of October 31, 2014. Mid Cap Value Fund, its largest strategy achieved 11.6% in annualized returns since its inception in 2011 compared with the 9.8% return if the Russell Midcap Index.
Artisan Partners rely on analytical guardrails
During a recent interview with Value Investor Insight, James Kieffer and his co-managers Scott Satterwhite, George Sertl and Daniel Kane emphasized that they “focus more on issues impacting the business and make thorough judgment on those.”
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Artisan Partners believed that “out-modeling” everyone else is not the key to success in investing. Its portfolio managers rely on analytical guardrails to keep out of the ditch by reducing the frequency and severity of loss.
Kieffer emphasized that managing risk is the core of Artisan Partners’ investment strategy. According to him, they manage risk by looking for companies with solid return-on-capital and cash-flow capabilities. They manage financial and valuation risks by requiring strong balance sheet and by pursuing opportunities that out of favor and selling cheap.
Kieffer said at Artisan Partners, they consider their portfolio as a conglomerate and the index as a competitor. They want their portfolio to be of higher quality, value and financially stronger than the index.
Artisan Partners finds technology firms financially sound
On the other hand, George Sertl explained that Artisan Partners become more interested in technology companies over the past few years because they tend to be financially sound with very little debt and lack pension plans or other liabilities.
Sertl added that the business models of tech firms tend to be assets light, generates significant cash and good returns on capital. Artisan Partners also noted that the valuation if tech firms transformed from one of the most loved to one of the cheapest since 2000.
Sertl mentioned that Artisan Partners owns a stake in Apple Inc. (NASDAQ:AAPL) and Samsung Electronics Co Ltd (LON:BC94) (KRX:005930). According to him, the consumer brands of both companies are among the strongest worldwide.
Artisan Partners considers banking an ultimate commodity
When asked about the banking sector, Kieffer explained that Artisan Partners consider it as an ultimate commodity—buying and selling money. According to him, they normally require a cheaper price to invest in a bank.
Artisan Partners is more interested in property/casualty insurance citing the reason that the best underwriters can generate returns over time. The firm still owns a stake in Arch Capital Group Ltd. (NASDAQ:ACGL).
Kieffer emphasized that Arch Capital CEO Constantine Iordano learned the business from Warren Buffett’s Berkshire Hathaway Inc (NYSE:BRK.A) (NYSE:BRK.B). According to him, Arch Capital is very opportunistic.
Another big holding is Avnet.
Artisan Partners states:
The company sells products from over 300 technology suppliers, including all the big names, to more than 100,000 customers worldwide. It focuses on selling into small and midsize businesses where big suppliers like H-P, Cisco and Oracle can’t justify an in-house sales effort. Avnet and Arrow have leading market shares and are among the few players that operate globally.
Most competitors tend to be more geographically or product-vertical focused While technology-product distribution is a fairly mundane business, we like that it’s a solid and sustainable one. We expect it to grow with global technology spending, and that distribution over time will take somewhat more share as new geographies develop. Scale is a benefit, so we also expect some individual share growth for Avnet, both organic and driven by M&A.
As I mentioned earlier, the business has compounded very well over time. Over the past ten years Avnet’s revenues have grown 10-11% per year, from $10 billion to $27 billion, while earnings per share, estimated in the current fiscal year at around $4.50, have compounded at 15% annually. Debt is not a real concern. The company as it has grown has kept net debt around $1 billion over the past decade. Current interest coverage is about 8x.
The distribution business isn’t as buffeted by changing technology because distributors sell it all. But what they sell and the economics around that clearly evolve. Years ago, for example, Avnet sold a lot more servers and a lot less storage and software than it does today. I honestly don’t have a firm conclusion on the cloud’s impact.
There is some value-add in the company’s offer – it has more than 1,000 engineers and essentially serves as the chief technology officer for many of its customers. As technology evolves, around the cloud and elsewhere, that value-added capability is likely to become more in demand. That would be a positive.
We think the real negative would be if it all went toward a public cloud, with companies outsourcing more and more of their IT capabilities. Given the security issues involved, I’m not sure a lot of businesses are going to hand over all their information to Google, Amazon and Microsoft. In any event, this is obviously something we monitor closely
The current revenue run rate is $28 billion, with mid-3% operating margins that, due to weakness in Europe, are a bit less than we consider normal. At the 4% operating margins management has targeted, the company would be earning closer to $5.50 per share. So the stock today is selling at less than 8x normal earnings and at book value.
This and other distribution businesses have traded for a lot higher multiples and we don’t understand why such a good business, with good bottom-line growth over time and a solid ROE, should trade at half the market multiple. In the meantime, the company’s underlying business has compounded at a nice rate and we think that should continue. If at some point we wake up and find the market ascribing a higher multiple, all the better.
When asked about Artisan Partners’ approach to valuation, Kieffer said their goal in valuation analysis is to establish an estimated range in a conservative way for a company’s intrinsic value. The firm’s portfolio managers used several tools including multiples of normalized free cash flow, price to book value, sum of the parts and M&A multiples.