By Serkan Unal
Run by Barry Rosenstein, JANA Partners is a hedge fund with $3.5 billion in assets under management. The fund is "a value-oriented investment advisor specializing in event-driven investing." JANA Partners applies a risk arbitrage strategy. Its investments are undervalued stocks with P/E below industry averages, high free cash flow, and attractive dividend yields. All its investments are based on thorough equity research.
Rosenstein is considered one of the most successful activist investors in recent years. He was instrumental in pushing for the breakups of several companies, including McGraw-Hill Companies (MHP) and Marathon Petroleum Corporation (MPC). In early October, Rosenstein presented his case for the break-up of the wholesale and retail distribution units of the Canadian fertilizer company Agrium Inc. (AGU). At the same time, he proposed a slew of cost-cutting and other measures that would significantly increase the company's value, adding as much as $50 per share to the company's stock price. Agrium publicly rejected the fund's initiative to spin off its retail business.
JANA Partners' strategies has been quite effective this year. For the first nine months of 2012, JANA Partners returned 18% compared with 5%, on average, for the hedge funds with similar "event-driven" investment strategies. At the end of the third quarter, more than 30% of the fund's portfolio, or about $763 million, was invested in Agrium Inc. The fund also holds large stakes in dividend payers McGraw-Hill Companies and Coca-Cola Enterprises Inc. (CCE). Here is a quick look at four new, smaller, dividend-paying positions in JANA Partners' portfolio, according to its latest 13F filing with the SEC.
Aetna Inc. (AET) was the seventh largest position in JANA Partners' portfolio at the end of the third quarter, worth almost $93 million. The company is a $15-billion diversified healthcare benefits firm. It pays a dividend yield of 1.8% on a payout ratio of only 15%. Its competitors Cigna Corp. (CI) and WellPoint Inc. (WPT) pay dividend yields of 0.1% and 2.0%, respectively. Aetna Inc.'s EPS expanded, on average, by 12% per year over the past five years, while its dividends grew at an average annual rate of 77%. This year, the company boosted its dividend by a still-robust 14.3%. Future dividend hikes are likely given Aetna's low payout ratio, strong balance sheet, and ample capacity to generate large cash flows. The company is attractive on valuation: its forward P/E of only 8.5x compares with 12.4x for the healthcare providers industry. The stock boasts a high free cash flow yield of 7.6%. The stock is also attractive based on its price-to-cash flow of 8.9 versus 12.7 for its respective industry. In August, Aetna Inc. announced plans to purchase Coventry Health Care, Inc. (CVH), another JANA Partners' holding, for $5.7 billion, which would bolster Aetna's exposure to government-based health plans. Coventry Health Care Inc. shareholders approved the deal in late November. The takeover will be completed by mid 2013. The acquisition, which is expected to add $0.45 to Aetna's EPS in 2014 and $0.90 in 2015, is a reason for the recent JP Morgan's upgrade of Aetna's shares to overweight from neutral, with a price target of $52 per share (raised from $46 per share). Aetna's shares are currently trading for $44.54 per share. Billionaire David Einhorn is also a major investor in Aetna Inc.
Teekay Corporation (TK) was a $32.5-million stake in JANA Partners' portfolio at the end of the third quarter. Teekay Corporation is a company engaged in the shipping of crude oil and gas. The stock is yielding 4.0%. The company is operating at a loss on a trailing-earnings basis, but expects to return to profitability next year. With forecast free cash flow of $120 million next year, the company may be able to maintain its dividend of $87 million a year. The regular quarterly payout has been unchanged since October 2008. Teekay Corporation's competitor Frontline Ltd. (FRO) suspended its dividend payouts earlier this year. While Teekay Corporation expects some improvement in its operating environment in the future, Standard and Poor's remains pessimistic. It recently downgraded Teekay Corporation's long-term corporate rating saying that the company, operating on "highly leveraged" financial and business risk profiles, "will continue to generate low profits (given that) the shipping industry will remain depressed." In terms of valuation, Teekay Corporation has a price-to-book above the industry average. However, it is trading at price-to-sales and price-to-cash flow ratios below those of its respective industry. Among fund managers, Alec Litowitz and Ross Laser from Magnetar Capital (check out its top picks) as well as Jacob Doft (Highline Capital-see its major holdings) are among top hedge fund investors in the company.
Rockwell Collins Inc. (COL) was a $28-million position in JANA Partners' portfolio at the end of the third quarter. The company is a maker of communications and aviation electronics for commercial and military customers. It is paying a dividend yield of 2.1% on a payout ratio of 29%. Its rivals Honeywell International (HON), Raytheon Co. (RTN), and L-3 Communications (LLL) yield 2.6%, 3.5% and 2.6%, respectively. Over the past five years, Rockwell Collins Inc.'s EPS and dividends grew at average annual rates of 3.8% and 12.2%, respectively. The rate of EPS growth is expected to accelerate to 9.4% per year for the next five years. The stock is attractive on valuation: its forward P/E of 12.6x compares with 14.5x for the aerospace industry. However, based on price-to-book, price-to-sales, and price-to-cash flow, the stock is quite expensive relative to its industry on average. Still, Rockwell Collins Inc. has an exceptionally high ROE of 44%. While the company posted fiscal fourth-quarter EPS that beat analyst estimates, growth in the business aviation market will be hampered in the near term by a slow global economic expansion. The company expects to return to growth by 2014/2015 and to see accelerated growth in the subsequent years. With a strong cash flow generating capacity, the stock has been increasing shareholder value through significant share buybacks. Its share repurchase plan has some $481 million remaining for stock buybacks. ValueAct Capital's Jeffery Ubben owns more, almost $566 million in the stock.
Pentair Ltd. (PNR), a water filtration and flow-control company, was a $21-million stake in JANA Partners' portfolio at the end of the third quarter. Pentair completed its merger with Tyco International's (TYC) Flow Control business on September 28, 2012, more than doubling the revenue for Pentair. Tyco roughly controls 52.5% of the combined company and Pentair owns the remainder. The merger allows Pentair to capitalize better on growth in the regions where rapid economic growth and urbanization are boosting infrastructure, energy and water demand. Pentair has increased dividends for 36 consecutive years. Currently, the company is paying a dividend yield of 1.8%. Its payout ratio is 37%, based on the current-year estimate. For the reference, Emerson Electric Co. (EMR), AO Smith Corp. (AOS), and ITT Corporation (ITT) are yielding 3.2%, 1.3% and 1.6%, respectively. Pentair Ltd.'s dividend is expected to rise by 4.5% in 2013. In addition to dividend growth, Pentair Ltd. is also boosting shareholder value through significant share buybacks. Recently, the company's board authorized a share repurchase program of $800 million, which will expire on December 31, 2015. This authorization is in addition to the $400 million authorization announced on September 28, 2012. The stock is trading on a forward P/E of 16.7x, compared with a high 25.1x for its respective industry. Glenview Capital's Larry Robbins is particularly bullish about this stock.