In this article we will evaluate Longleaf Partners holdings. Longleaf invest in strong businesses that are understandable, financially sound, competitively positioned, and have ample free cash flow that may grow over time. The fund also looks for businesses that are run by good people - honorable and trustworthy, highly skilled operators and capital allocators, who are focused on building value per share and have incentives aligned with their shareholders.
Longleaf has a rigorous valuation approach when selecting equities, buying only deeply discounted investments selling for 60% or less of Longleaf's appraisal value based upon the present value of free cash flow, net asset value, and comparable business sales.
With all these said, let's move to evaluate some of Longleaf Partners main ideas:
The fund sees a huge opportunity in Chesapeake Energy (NYSE:CHK) credit as the company's management projects additional asset sales this year and continue to renegotiate pipeline commitments toward better rates. It is also important to note that CHK put on hedges that help mitigate a potential downside in commodity prices.
In the last investor letter, Longleaf expressed confidence that CEO Doug Lawler and Chesapeake's board will successfully navigate the company through this particularly challenging commodity environment.
It is important to remark that in last April, Chesapeake had its $4bn revolving credit facility reaffirmed (90% untapped), with the next scheduled redetermination pushed out until June 2017. In addition, the company increased liquidity with the sale of about half of its mid-continent STACK acreage to Newfield at a fair price over $400m, reducing net debt by over 10% in 2016.
My recommendation: I still see value in the CHK 8% 2022 bonds at $100, yielding 8% to maturity. I think management will keep selling assets and reducing debt. Combine that with a more favorable pricing environment and there is still upside on the credit.
Longleaf initiated a position in Ralph Lauren (NYSE:RL), a leading global apparel and retail company. The bet here is on RL's new management team. After years of margin declines and overall industry uncertainty around the future of department stores versus e-commerce, Longleaf believes that new CEO Stefan Larsson will materially bolster the company's operating performance.
The base this view on the fact that Larsson has a superb track record of improving margins and reducing lead times in his previous positions at both H&M and Old Navy. Combine the power of a new successful CEO and a strong balance sheet plus smart capital allocation and you can get double-digit returns in this name.
Strong results appeared in the last earnings results as RL delivered strong revenue, improving margins and inventory down 2% YoY following an 8% increase at the end of 4Q. In addition, the company appears to already be making headway with shortening lead times to 9 months from 15, with 50% of the goal expected to be achieved by year end and up to 90% by the end of next year.
My recommendation: I like this pick and would be a buyer at prices below $92.50. With strengthened leadership in place, I think it is reasonable to bet in the team's ability to execute and improve profitability. In addition, the company's brand remain strong.
Longleaf is also a strong believer in Consol Energy (NYSE:CNX) management team. The fund likes the fact that management continue to focus on the company's core natural gas assets while monetizing non-core assets, with the goal of completely separating its coal company from its exploration and production businesses.
From an operational standpoint, the second quarter came in ahead of management expectations primarily due to higher shipments. Management is also seeing positive developments in the coal markets.
Interestingly, Consol reduced its coal and gas operating costs greater than consensus expectations, delivering positive free cash flow with strong guidance for the remainder of the year. The company also had its borrowing base reaffirmed at $2bn.
My recommendation: Similar to CHK, I prefer to be exposed to the credit instead of equity in this company. I see value in the CNX 5 7/8 2022, trading at $94.55 for a Yield to Maturity of 7.10%. While most of the rally in this bond has already materialized, I think that recent transactions confirmed the value of Consol's high quality natural gas assets. This gives long term protection for bondholders, while providing solid income going forward.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.