On August 20, The Wall Street Transcript interviewed Douglas R. CannonD, founder and Chief Investment Officer of Texas First Investment Management Company. Key excerpts, including his long-term Texas-based value picks, follow:
TWST: What are some of those companies you feel are representative of your investment approach, both small cap and large cap?
Mr. Cannon: In terms of our largest holdings, Reliant Energy (RRI) is a good example. Reliant is a large cap company that several years ago was losing money about every way a company could lose money. They changed their corporate strategy partly on the premise that the utility industry is in a long-term consolidating mode. Some companies will be acquiring other companies and others might be acquired. They didn't have the size or financial strength to be an acquirer. They decided that the best way to create shareholder value was to pull back from their many different areas of operations and focus on their critical area of providing electricity. They cleaned up the balance sheet and they brought in a new management team. A very good indication I noticed several years ago was they brought in a Goldman Sachs investment banker to be their Chief Financial Officer. That was a red flag to me that perhaps they were thinking about selling the company at some point. In May of this year, they promoted the CFO to CEO. They've not sold the company yet, but because they've done such a good job repositioning the company by selling off operations that didn't quite fit in and paying down the debt, the stock's had a good run. We bought Reliant about two years ago at an average price of $11 and it's moved to $28, so we have a 150% gain in that stock. The utility industry continues to be a consolidating industry, so I feel there is still a 20%-30% buyout premium in the future sometime. This is the third time in seven years that we have taken a position in Reliant and it has done well for us each time.
Another good solid company in our large cap portfolio is Sysco (NYSE:SYY). It's the largest food wholesaling company in the country; they are just a world-class food wholesaler. Sysco has had consistent revenue and earnings growth over the years. In fact, it's a growth company selling at a value price. Sysco stock is not something that may move overnight, but over time the company is going to provide some solid gains.
Another large cap example that illustrates our value theme is Temple-Inland (NYSE:TIN), a forest products company. We purchased that about three years ago at $20; it's now at $58, so the gain there is about 180%. The stock price has benefited from a couple of things. Number one is just fundamental improvement in the building materials and forest products sector. Two, Temple is a conglomerate of three different types of operations. First is the production of paper and construction products. Second is the ownership of a great acreage of forestland. Third, they have a financial subsidiary, Guaranty Bank, which they purchased at a distress price during the S&L crisis in the 1980's. Carl Icahn came in about six months ago and strongly made the case that here's a company where the parts are worth more than the whole and you don't have to have these three pieces connected. The company then made a strategic decision that they would in fact go along with Mr. Icahn's advice and decided to break the company up into the three pieces. We should continue to see improvement in the stock price as Temple-Inland is separated into three new entities.
One value in the mid cap arena is Belo Corporation (NYSE:BLC). Belo is a high quality, well-managed media company. It is the parent company for The Dallas Morning News and they own a number of television stations. There's a lot of interest in the media sector in terms of both strategic and financial buyouts from other media companies as well as LBOs. We saw a good example of that with the recent acquisition of Dow Jones. Belo Corp. has been on my radar screen forever, and I've been waiting to get the right combination of price and outlook. We came in and bought it about seven months ago. In terms of price potential, we think Belo Corporation has a very strong attraction to both financial companies that might buy it in a private equity deal or from a News Corp. type perspective where you get a strategic buyer. In any event, it has solid underlying value as a stand-alone company.
TWST: Do you have an example of a small cap?
Mr. Cannon: One of the undervalued small cap companies we've invested in is Administaff (ASF). It's a company that provides temporary employment, personnel and administrative services to companies that are not large enough to have their own well-qualified personnel and payroll departments. The stock declined from $58 in May 2006 and we picked it up this year at $35. Earnings continue to be on the upside. There can be a cyclical nature in a company like this due to shifts in healthcare costs and changes in the economy, but it's a world-class franchise that over the years will grow. ASF has a large-scale share buyback program. It's our second trip around with Administaff. We bought it about four years ago and sold it a couple of years later at a good profit.
Another small cap stock we own is Franklin Bank Corp. (FBTX). It is not really well known, but it's a chain of banks primarily in Texas. It has some very smart management including a Director named Lewis Raineri, who some folks in Wall Street may be familiar with. He bought over 250,000 shares in June 2007 at a price of $15.70. Other Directors have also been buyers. The stock price declined sharply in recent months and is now only $9, even though the average of analysts' 2008 earnings estimates is $1.40. We think the market has way over-compensated for any lending-related risk and it's now attractive from a couple of viewpoints. One is simply based on the fundamentals, such as the low price-to-book and the low price-to-earnings. Secondly, it would be an ideal pickup for a bank trying to get a beachhead here in Texas. It's very intriguing that eight high-caliber investment firms each own 5% or more of the stock.k