In the second of a two-part interview, Javier Sáenz de Cenzano, Director of Fund Analysis for Morningstar in Spain, talks to Marvin Schwartz and Henry Ramallo, fund managers for UBAM Neuberger Berman US Equity Value about their view on the information technology sector, financials, and the US property markets. The managers currently have 25% of their portfolio invested in six technology companies, which they believe are still relatively cheap. To view their take on US equity markets overall and the energy sector, watch the first part of this interview.
Javier Saenz de Cenzano: Okay, now moving on to the information technology sector; it is a sector where you've building a position over the last couple of years; it is now quite a significant chunk of the portfolio. What's the story there? What are the main drivers of the sector? What kind of companies are finding? I see in your top ten holdings, companies like Microsoft, IBM, Hewlett-Packard. What's the view on that and what's the main rationale for those companies?
Marvin C. Schwartz: As you pointed out earlier, we have approximately 25% of the portfolio invested in technology. It consists of six companies. I believe five of the six companies are debt free, generate big amounts of cash, and sell at very low price earnings multiples. Our largest single investment in the portfolio is IBM. The stock is selling at 10.5 times next year's earnings. The management has publically forecast that the earnings are going to grow to $20 a share minimum by 2015. That compares to $10 a share in 2009. Our own analysts believe that the real earnings in 2015 will be higher than that. We believe that IBM is a stock that could double in value in the next three to four years.
Another stock in that space, that's incredibly cheap right now, is Hewlett-Packard. This stock was selling a few months ago at $53 a share. The Board of Directors of the company made a decision that we disagree with and others do too, to remove its highly capable Chief Executive Officer, Mark Hurd; he was one of the finest CEOs of any company in the United States. As a result of his removal, the stock got very weak. It is selling right now at eight times earnings. The management of the company recently revised upward their earnings for next year to about $5.10 a share and they announced a huge share buyback program which they are in the process of implementing. We think this stock will have significant appreciation over the next 12 months.
Henry Ramallo: One of the other things that make this sector very attractive to us is that these companies are able to grow their earnings by making acquisitions of very small niche path companies and products. They are able to take primarily small North American based companies that have very small distribution maybe in the US, and they realised it's filling a hole or providing a new product offering, and they could immediately distribute it worldwide. Like for example, IBM has sales to 160 countries worldwide. Oracle for example has been averaging almost an acquisition a month, and the more they do of this, the more they are able enhance their revenue because they are able to sell it on a much larger basis.
The most recent example on a largest acquisition was Xerox taking over ACS. ACS, 85% of their sales were just in the United States. The 15%, a large portion came from Canada, so you could say upward of 90% of the ACS's sales came from North America. Well, Xerox has taken that and put it on their revenue was roughly 50-50 prior to this deal, between US and outside the US They are putting that on their platform, and they recently just moved it – got a very nice contract I believe in the UK, and only they expect much more to come. So, today, as a matter of fact, Xerox recorded and they were able to take their earnings estimates up officially from a range of $0.95 to $1.05 for next year to $1.05 to $1.10, and I am certain, it's not just the synergies, the cost savings on the deal, it's more for the fact that they're seeing a lot more new opportunity to sell the products that ACS had.
Cenzano: And why do you think the market is not yet reflecting that potential of these companies, or why are they still so cheap, at such slow pace?
Schwartz: I think, one has to have patience. Companies like Xerox and IBM and Accenture, three of our other holdings, they are all selling approximately within one or two points from their 12 month high. So to some extent it's beginning to get reflected, but I think it has a long way to go.
Cenzano: And the other interesting sector in the portfolio is financials. There are few insurance companies in the portfolio and some banks, such as J.P. Morgan, Bank of America. What's your view on the whole financial sector in the US? Do you think the worse is over and we are now getting to better times or do you still have some concerns about the whole industry? And especially if you think about these companies, what do you like about them?
Schwartz: We think the industry is in the process of healing. We do not own Bank of America in the portfolio. We sold that a number of months ago. We do own J.P. Morgan. But one of our very favourite stocks in the portfolio was Travelers insurance company. The stock made a new high today, I believe, at $55. But its earnings well over $6 a share. It sells at a discount from book value. The company generates a huge amount of cash every year. The management is very, very aggressively buying the stock. This is one of the 30 Dow Jones companies, and the shares outstanding are being contracted dramatically. Three and half years ago, they had 700 million shares outstanding. December of 2009, they had 520 million shares outstanding. We believe that by December 2010, they are going to have 430 million shares outstanding, and we think that this stock is doubled in three or four years.
Ramallo: Of the 18.5% in the portfolio within in the financial sector, currently only 3% is in banking. The rest is all in insurance companies, primarily with one stock about 2.5% to 3% is an insurance broker, AI, which again we feel very comfortable owning, and I think, expect much more from them.
Cenzano: Do you have any view on the real estate sector, as a whole in the US? Do you think we've already gone to the bottom, and it's going to recover in the next few years?
Ramallo: On housing prices, we've seen the bottom. We've now had five or six months in a row, where the Case-Shiller numbers have shown dramatic – well, I wouldn't say dramatic, but inconsistent improvement in the average price of a home in United States. The noise that we're hearing regarding foreclosures is more noise than it is. It's not as much hardship as people make it out to be. There is a lot more where people are walking away because as in Spain and other parts of the world, where the values of homes have come down and the mortgage is greater than the value of the home, too many people are walking away without any long term consequence.
So, that's the remaining bulk of the foreclosure that's left to happen. It's more by choice than it is hardship. So, yes, we've seen the worst, places like Michigan that were hardest hit – one of the hardest hit states throughout the whole debacle. Because Michigan happens to has where Detroit is, and it takes into account the automobile industry and we all know what happened with the automobile industry and a lot of people lost their jobs and wound up some losing their homes.
This year to date, Michigan has seen the best appreciation, both in home sales, values of homes, and believe it or not, in labour improvements. So, jobs are actually coming back to Michigan. It was a very highly trained workforce. So as you get continued confidence and that's the real missing ingredient to the market in my opinion doing better, I should say, in our opinion doing better. As we start to see more evidence in housing not continuing to slide and values maybe creeping up and labour numbers, unemployment numbers coming down. I think, we're setup for nice recovery in the US market.
Schwartz: The 30 year mortgage rate is at an all-time low of about 4.2%. That compares to 9.25%, which it's averaged for the last 35 years. We think there is tremendous pent-up demand in housing waiting to get unleashed. It needs a trigger, it needs a catalyst. It hasn’t appeared on the scene yet. But housing has been in a recession now for three and a half years, and it's getting very close to coming out of it.
Cenzano: Okay. Thank you very much, Marvin, Henry. It's been a pleasure. Thank you all for your support.
Schwartz: Thank you.
Ramallo: Thank you.
Cenzano: Thank you.
