Value Hedge Fund Chieftain Capital's Top 2 Stock Picks

| About: Tempur Sealy (TPX)

John Shapiro founded Chieftain Capital with Glenn Greenberg in 1984. Chieftain reported returns of 22.5% before management fees, or roughly twice that of the S&P 500, which returned 12.9% for the same period, from its inception through 2004. Chieftain split up in 2010. Shapiro left the company along with partners Tom Sterna and Joshua Slocum. The trio started a new firm but opted to keep the Chieftain name, while the original Chieftain Capital, managed by Glenn Greenberg took the name Brave Warrior Advisors.

Shapiro's Chieftain Capital uses a value investing strategy and, true to the company's roots, keeps a narrow portfolio. The idea is that with fewer positions, the manager can pay closer attention to events or trends that could affect a stock's pricing. In this article we will cover Chieftain Capital's top two stock picks. According to a 13F filed with the SEC on February 14, Chieftain Capital has just 11 holdings, collectively valued at $1.62 billion. The largest of these is a 5.18 million share position in mattress company Temper Pedic International (TPX), which was valued at $272.27 million at the end of the fourth quarter. Temper Pedic was also Chieftain Capital's largest position at the end of the third quarter, but its position was smaller then, weighing in at just 4.83 million shares or a value of $254.09 million at the end of September.

Temper Pedic closed trading on February 17 at $73.56 a share on a mean one-year target estimate of $79.60. The company does not offer a dividend but it is priced fairly low relative to its future earnings, with a forward P/E of 16.10. Over the last 52 weeks,

Temper Pedic has returned 57.58%, well outpacing the market, which returned just 3.48% over the same period. To its favor, over the last five years, Temper Pedic's earnings have grown by 20.88% per annum on average. Analysts expect this growth will taper down some, giving an earnings growth estimate of 15.86% per year on average over the next five years. It sounds encouraging, but expectations for its industry are more than twice as high, weighing in at 33.78%. Still, we think Temper Pedic is a winner.

Looking at Temper Pedic relative to its closest competitor - Select Comfort (SCSS) - the advantages of Temper Pedic are clear. Select Comfort was trading at $28.05 a share when the markets closed on February 17, with a mean one-year target estimate of $33.75. The company also does not pay a dividend and is priced higher relative to its future earnings, with a forward P/E of 16.50. Over the last 52 weeks, Select Comfort's share price has swelled over 151%. Looking at analyst expectations about its growth, there is even less reason to choose Select Comfort - the company's earnings have grown an average of just 8.73% per annum over the last five years and are expected to increase by just 15.00% per annum on average over the next five years.

Jim Cramer said on February 10 that he prefers Select Comfort, in spite of it being priced marginally higher - and Tempur Pedic had an adjusted close price of just $71.11 that day. But, we disagree. While both companies look great, we like Tempur Pedic's lower pricing and higher expected earnings growth. Granted Select Comfort does not have the high levels of debt that Tempur Pedic does, which can make it look like Tempur Pedic is over-priced, but Tempur Pedic also recently launched a series of lower price point mattresses, which accounts for much of the debt and could pay off hugely. Especially with the economy being sluggish, we think a series of lower priced mattresses will provide the edge Tempur Pedic needs going forward. Jim Simons' Renaissance Technologies is also a fan.

The second largest position in Chieftain Capital's portfolio at the end of the fourth quarter was a 3.72 million share stake in Time Warner Cable (TWC). It was worth $236.53 million at the end of December. This represents a marginal increase from the third quarter, when Chieftain Capital held 3.66 million shares in the company, worth $229.31 million at the end of September.

Time Warner had been in a deadlock with MSG Media. The latter is part of the Madison Square Garden Company (MSG). In addition to producing and airing events at Madison Square Garden for television viewing, MSG Media develops content for a variety of networks, including the MSG family of networks (MSG, MSG Plus, MSG HD, and MSG Plus HD) as well as many regional sports networks - like the NY Knicks and NY Rangers - and the Fuse Networks (Fuse and Fuse HD). The issue was the carriage fees that MSG was charging Time Warner. The stalemate lasted roughly 48 days before Time Warner and MSG were able to come to a multi-year agreement effectively putting the matter to rest, which they reached in mid-February.

Time Warner closed trading February 17 at $77.66 a share with a one-year target estimate of $85.88. It pays a $2.24 dividend (2.90% yield) and is priced at just 11.71 times its future earnings. Analysts give Time Warner an earnings growth estimate of 13.70% per annum over the next five years, compared to 16.13% for its industry. We highly recommend Time Warner.

Chieftain Capital's 13F portfolio is a great starting point for uncovering value stocks. Aon Corp (AON), Crown Holdings (CCK), Dun & Bradstreet (DNB), Laboratory Corp of America (LH), Lockheed Martin (LMT), US Bancorp (USB), and Western Union (WU) are among Chieftain's other large holdings.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.