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).
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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 as if we were buying a $10 million office building across the street. We do our homework on the tenants and the leases in place and make sure it’s financed in a way that produces a 10% free-cash-flow yield. The idea is to increase equity by paying down debt with the free cash flow and also to benefit from the asset appreciating over time. With stocks, if you focus on companies with around 10% free cash flow yields and highly predictable, sustainable franchises, you protect your downside and set yourself up for nice capital appreciation.
What kind of a sell discipline do you typically follow?
AR: We try to keep it fairly rigid. When a holding hits some combination of 8x EBITDA, 12x EBIT or 15x forward earnings, we’re going to start selling. That means the shares are in the top end of their valuation range and we can’t expect enough further upside. When Sonoco hit a 15x forward P/E there was just no further reason for us to be in the stock. Same with Black & Decker [BDK], which we also recently sold after a good run. Not only did the valuation get relatively high, but we became increasingly concerned about the company’s exposure to a housing market that is likely to be troublesome for some time.
Central to your strategy is to have position sizes that ensure an active dialogue with management. Why?
AR: Being an activist has taken on a bit of a negative connotation in the past few years, but we absolutely want to be constructively-engaged shareholders. We have 10-15% of our capital in each of our core companies, so I just think it’s imperative that we make our views, particularly with respect to capital allocation, clear. For the most part, management appreciates the faith we’re placing in their business and in them to get the stock out of the valuation hole it’s in.
And when they don’t appreciate it?
AR: When management is unresponsive, we work to change that. We’ve had a successful investment in Schindler, the elevator company based in Switzerland. But when I first called to arrange a meeting with Mr. Schindler after becoming the third-largest shareholder, I was told that he doesn’t meet with shareholders. I suggested that Mr. Schindler could instead arrange a meeting with his bankers about taking the company private, so he could maintain that attitude. We eventually met for 2 1/2 hours and now have a good relationship.
I don’t like proxy battles, I just want to make money and maintain my liquidity. The moment you force yourself on a board, you become illiquid. We do get frustrated from time to time, as a result of management inaction or when we don’t think it’s acting in shareholders’ interest.
With Dole Food, for example, it appeared to us that the chairman in 2002 was taking actions that held back the share price and then he subsequently tried to buy the company for a paltry premium. We were the second-largest shareholder and called him on it publicly and he eventually had to pay substantially more. That’s a rare scuffle; we generally try to operate more behind the scenes.
Do any market environments tend to give you trouble?
AR: I’d say that when investors focus particular attention on a given sector – like technology stocks in the late 1990s or energy and commodity stocks more recently – we’re unlikely to outperform. Multiples get compressed in our universe in those times, so it’s tough for us to beat an index increasingly weighted by the hot sector. We’ve held our own over the past three years, but it hasn’t been easy having no energy/commodity producers and quite a few energy/commodity consumers in our portfolio.
What’s your biggest single worry about the market today?
AR: In our view, the world economy looks pretty healthy. But I do believe there’s reason to worry about systemic risk that could be triggered rather easily by one type of geopolitical event or another. I think there is an unknown but possibly very large amount of leverage in the system. If there is a dislocation, we’d very much prefer to be invested as we are – without leverage, in profitable companies with strong balance sheets and attractive end markets.