Bruce R. Berkowitz, an equity fund manager and investment adviser, founded Fairholme Capital Management at the end of 1999. In less than ten years, he was able to generate a $9 billion portfolio, $7.2 billion of which is in the Fairholme Fund (FAIRX), which he also manages. Most importantly, Fairlohme has occupied the top Morningstar category in the last five-year period. The fund is able to generate annualized returns over 9%, exceeding the S&P 500 average.
Bruce Berkowitz is a long-term player in the investment environment. He follows Benjamin Graham´s philosophy. His portfolio is usually made up of 22 stocks and two bonds and he generally chooses companies that are financially healthy, generate strong cash flows, hold solid assets and are correctly managed. In the last period he has been investing in companies from the financial sector due to the increase of his interest on this type of entities.
I find it essential to buy companies that sell products and services that are needed and have no close substitute. I analyzed Berkowitz´s portfolio and discovered that he also shares those business principles. I will now detail his holdings and the reason why he could have chosen the stock.
American International Group (AIG): AIG is a holding company that operates through its subsidiaries to provide a wide range of insurance and related activities within the US and abroad. Some of the services it renders include insurance, financial and investment products and services to both businesses and individuals. AIG´s subsidiaries operate by means of a property-casualty and life insurance and retirement services network. AIG' segments include Chartis (49%), SunAmerica Financial Group (19%), Divested Businesses (19%), Financial Services (6%) and Other Operations (7%). Last but not least, AIG stock is listed on the NY Stock Exchange, but it also trades at the stock exchanges in Ireland and Tokyo.
What I find interesting about AIG is that the company has been able to recover the value of its investments after the economic downturn of 2008. This recovery has enabled AIG to get rid of redundant and risky businesses at interesting prices and improve its financial leverage and reduce interest expenses. Furthermore, AIG has a BBB rating on its senior debt showing a stable outlook. S&P Ratings also upgraded AIG.
Now, the company is trying to re-enter the securities lending business, which will surely bring a growth in earnings and tax savings given its deferred tax assets. Last but not least, the company has launched initiatives to restructure itself and re-establish prices to improve returns in the foreseeable future. Proof of how well these initiatives are working is the company´s long-term goal of achieving mid-teens earnings growth along with +10% growth in ROE by the end of 2015, from $2.62 per share and 6.2% ROE, respectively, at the end of 2010. It is interesting to read AIG's restructuring plans here.
I also like AIG because its unique operational focus and management discipline, even though the extremely competitive environment it is involved. This focus and discipline have allowed AIG to be on track again. In addition, the positive pricing trends and better situation at SunAmerica has enabled AIG to improve retirement and variable annuity products along with assets under management. In April 2011, SunAmerica financial strength rating was upgraded from A- to A, given its stable look, the reduction in investment losses, and higher capital adequacy metrics. In the last quarter, SunAmerica´s pre-tax earnings surged about 43% year over year to $2.02 billion in the first nine months of 2011 and about 74% over 2009 to $4.0 billion in 2010.
Finally, the purchase of AeroTurbine should enable ILFC improve value in the aircraft complete life cycle. These operations should trigger growth, mitigate operation risks and make AIG financially flexible once again.
AIG´s current net profit margin is 26,44%, currently higher than its 2010 margin of 2.05%. I like Companies that increased profit margins in comparison to other years. It is essential to know the reason why that happened. The current return on equity for AIG is 28.72%, higher than the +20% standard I look for in companies I invest and also higher than its 2010 average ROE of 23.67%.
In terms of income and revenue growth, AIG has a 3 year average revenue growth of 110.41%. Its 3 year net income average growth has not been reported. Its current revenue year over year growth is -17.14%, lower than its 2010 revenue growth of 2.89%. I do not like when the current revenue growth is lower than in past years. It generally shows that the business is decelerating for some reason. The current net income year over year growth is 128.59%, and its net income y/y growth for 2010 has not been reported. I like when the net income growth is high.
In terms of valuation ratios, AIG is trading at a Price/Book of 0.5x, a Price/Sales of 0.8x and a Price/Cash flow of 1428.6x, in comparison to its industry averages of 0.8x Book, 1.0x Sales and 10.0x cash flow. It is essential to analyze the current valuation of American International Group and check how is trading in relation to its peer group.
AIG is making every effort to restructure its operations to increase leverage and generate more capital to repay the government´s bailout money. This will release the company from federal restrictions. Moreover, the company has divested assets to focus on core life and property-casualty businesses. This change of focus has enabled AIG to improve its position in the US.
Despite these positive elements, AIG must also be careful about the economic situation, as its slow recovery is making AIG stagnate. Other important issues that AIG should bear in mind are: the significant amount in non-recurring restructuring charges, catastrophe losses and low rate environment, jointly with high exposure. They may all affect the positive elements mentioned above, as they will probably reduce earnings at the beginning of 2012. The slow growth and shortfalls AIG is suffering also affect its payment ability.
Although these factors are risky, and may seriously affect the company´s performance, it is worth mentioning that AIG´s stock is increasing and will grow even more with the stabilization of the economy.
In terms of valuation per se, the shares of AIG currently trade at 11.4x 2012 earnings estimate, a 5% premium to the 10.9x industry average. On a price-to-book basis, the shares trade at 0.6x, which is at 25% discount to the 0.8x industry average. The valuation on a price-to-book basis looks stretched, given the negative trailing ROE of 2.5% that is substantially below the 3.1% industry average.
Financially speaking, the transfer of ownership from government will allow AIG to be again on its own. However, AIG´s debt load will be important thus demanding subsidiaries to generate income to meet these obligations. Any mistake in the operational performance or any extraordinary cost will severely affect the company.
CIT Group Inc (CIT): CIT is a Delaware Corporation involved in banking activities. The company, founded in 1908 operates through its subsidiaries and provides commercial financing and leasing products among other services to small and middle market businesses. CIT´s products and services are offered in the transportation, aerospace and rail industry, the manufacturing and retail industry and many other sectors across 20 countries. CIT is made up of the following segments: Corporate Finance, Transportation Finance, Trade Finance, Vendor Finance, Consumer, Corporate and Other.
What reasons do I find to invest in CIT? The first is its initiative to aggressively restructure its liability profile. In 2009 CIT made a very compelling restructuring plan that is going well. The link to that plan could be found here. CIT is trying to repay and refinance its debt. Indeed, in 2010, the company lowered its debt load by eliminating and refinancing $15 billion of first lien and second lien debt. In Q3 2011, CIT renewed a $550 million conduit facility at a lower cost and in the long term. Finally, in August, CIT announced a new $2 billion revolving credit facility that provided more financial flexibility.
The second reason is related to CIT´s permanent efforts to expand its market share. For such purpose CIT announced, in November, the launch of CIT Real Estate Finance business, which is expected to provide real estate loans over $20 million to well capitalized and experienced developers in the office, retail, industrial and multi-family rental sectors. In October, the company announced the launch of an online bank to offer FDIC-insured Certificates of Deposit (CD). The online bank will allow CIT to significantly expand its client base.
I think that all these initiatives CIT is engaged in will contribute to its revenue growth in the upcoming years.
CIT´s current net profit margin is 1.30%, currently lower than its 2010 margin of 15.73%. I do not like companies with lower profit margins than in the past. That could be a reason to analyze why that happened. Its current return on equity is 0.30%, lower than the +20% standard I look for in the companies I invest and also lower than the 2010 average ROE of 5.97%.
In terms of income and revenue growth, CIT has a 3 year average revenue growth of -11.37%, and its 3 year net income average growth has not been reported. Its current revenue year over year growth is -37.50%, lower than its 2010 revenue growth of 148.75%. I do not like when the current revenue growth is lower than in the past year. It generally shows that the business is decelerating for some reason. The current net income year over year growth is -94.90%, lower than its 2010 net income y/y growth of 184.21%. I do not like when current net income growth is lower than in the past year. I look for companies that increase both profits and revenues.
In terms of valuation ratios, CIT is trading at a Price/Book of 0.9x, a Price/Sales of 3.9x and a Price/Cash flow of 9.4x, in comparison to its industry averages of 1.9 x Book, 2.3x Sales and 10.0x cash flow. It is essential to analyze the current valuation of CIT Group Inc and check how is trading in relation to its peer group.
As regards valuation per se, CIT shares currently trade at 33.8x the earnings estimate for 2012, a significant premium to the 16.2x for the industry average. On a price-to-book basis, the shares currently trade at 0.8x, 58% discount to the industry average of 1.9x. The valuation on a price-to-book basis looks attractive given a trailing 12-month ROE of 1.9% versus the negative industry average.
Bank of America Corporation (BAC): BAC is a financial holding company that operates through its banking and non-banking subsidiaries in the United States and in international markets. It provides several banking and non-banking products and services through the following business segments: Deposits (13%), Card Services (18%), Consumer Real Estate Services (1%), Global Commercial Banking (11%), Global Banking & Markets (24%), GWIM (18%) and All Others (15%).
I think one of the key reasons I like Bank of America is the bank's advantage of its large scale to incorporate new products in the retail segment. Furthermore, the company generates strong results in Investment Banking. Most importantly, Bank of America occupies the second position in investment banking fees across the globe. The Bank has been able to raise its market share from 7.4% to 6.8% in 2010 and this positive trend will surely continue in the years to come offering higher leverage.
I also feel that Bank of America is a solid pick because BAC is an important capital market player that always benefit from the growth in capital markets. BAC is very strong in consumer and commercial banking, credit card operations and asset management. These three segments will benefit from the recovery in the US economy. Finally, management prefers organic growth over acquisitions because it brings advantages as to cost, risks and cultural fit.
BAC´s current net profit margin is 0.09%, higher than its 2010 margin of -3.26%. I like companies that increased profit margins in comparison to other years. It is essential to know the reason why that happened. Current return on equity for BAC is 0.04%, lower than the +20% standard I look for in companies I invest but higher than its 2010 average ROE of -1.77%. In terms of income and revenue growth BAC has a 3 year average revenue growth of 8.69%, and a 3 year net income average growth of -28.81%. Its current revenue year over year growth is -15.21%, lower than its 2010 revenue growth of -7.88%. I do not like when current revenue growth is lower than in the past year. It generally shows that business is decelerating for some reason.
In terms of valuation ratios, BAC is trading at a Price/Book of 0.4x, a Price/Sales of 0.9x and a Price/Cash flow of 1.3x, in comparison to its industry averages of 0.9 x Book, 1.8x Sales and 4.1x cash flow. It is essential to analyze the current valuation of Bank of America Corporation and check how is trading in relation to its peer group.
It is a must to analyze the company´s valuation: shares are currently trading at 11.6x the 2012 earnings estimate. This involves an 8% increase vis-à-vis the industry average of 10.7x. On a price-to-book basis, the shares trade at 0.4x, a 60% discount to the industry average. The valuation on a price-to-book basis looks reasonable, given a negative trailing 12- month ROE compared with the positive industry average.
At the end of the year, Bank of America reported a Tier 1 common ratio of 9.86%. This is not bad for regulatory purposes, but it will need to increase the ratio and maintain it in a conservative manner--under Basel III.
MBIA Inc (MBI): MBI is a company that provides asset, investment, and treasury management services along with the underwriting of municipal bond insurance and municipal and structured finance obligations. After the reorganization of Cutwater, the company changed its Investment Services Segment to Advisory Services and created a new one: Wind-down operations. Now it reports on four instead of three services, to wit: U.S. Public Finance Insurance (41%), Structured Finance and International Insurance (49%), Advisory Services (1.5%), Wind-down Operations (8.5%).
One important reason I found to invest in MBI is the fact that the company engaged in restructuring efforts (link here) to capitalize National Financial Guarantee with $5.0 billion in 2008 to separate the business of insuring structured financial obligations, which was a very riskier business from the traditional bond insurance.
Unfortunately, holders of MBIA Insurance policies filed a complaint against MBIA for the restructuring movement on the grounds that this move would render MBIA Insurance unable to pay out future claims. Despite this event, MBIA has been able to reach an agreement with 14 banks. MBIA has been correctly handling the situation, thus enabling National Public to get better ratings and write new business.
Another important reason I researched is the fact that it is BBB rated on its municipal bond insurance unit. According to S&P, the company´s business and financial risk profile is strong. Furthermore, the stable stream of premiums and investment income contribution will provide support to National insofar as it remains inactive and its strong distribution and management team may position it well in the market once the litigation is settled.
MBIA´s current net profit margin has not been reported in 2011. In 2010, its margin has been of 5.88%. Current return on equity for MBIA is -58.21%, lower than the +20% standard I look for in companies I invest and also lower than its 2010 average ROE of 1.94%. In terms of income and revenue growth, MBIA´s 3 year average revenue growth has been reported neither in 2011 nor in 2010. Its current revenue year over year growth for 2011 has not been informed, while for 2010 it was -69.74%. The current net income year over year growth was not reported in 2011 and in 2010 it amounted to -91.64%.
In terms of valuation ratios, MBIA is trading at a Price/Book of 1.1x, a Price/Sales of -1.2x and a Price/Cash flow of -0.6x, in comparison to its industry averages of 1.0x Book, 1.0x Sales and 11.3x cash flow. It is essential to analyze the current valuation of MBIA Inc and check how is trading in relation to its peer group.
What about valuation? MBI shares are volatile given a beta of 2.5. This volatility can be affected by the outcome of the issues related to National and the lawsuits related to put back recoveries, which are uncertain. MBI´s exposure to commercial real estate through structured CMBS pools, CMBS and CRE, CDO makes it vulnerable to losses.
Sears Holdings Corporation (SHLD): SHLD is one of the largest broadline retailers in the US. It provides home appliances, tools, lawn and garden equipment, electronics, automotive repair and maintenance products across the country through almost 4,000 stores. The company receives over 11 million service calls annually. The company operates through its brands, Kenmore, Craftsman and DieHard, Lands' End, Jaclyn Smith, Joe Boxer, Apostrophe and Covington. The Illinois-based company reports its operating results under three segments: Sears Domestic (53%), Kmart (36%) and Sears Canada (11%).
Unfortunately the company is not performing well so there are not many reasons to recommend this stock.
SHLD´s current net profit margin is 0.31%, currently lower than its 2010 margin of 0.53%. I do not like companies that have lower profit margins in relation to the past. That could be a reason to analyze why that happened. Current return on equity for SHLD is 1.51%, lower than the +20% standard I take into account in companies I invest and also lower than its 2010 average ROE of 2.54%.
In terms of income and revenue growth, SHLD has a 3 year average revenue growth of -5.11%, and a 3 year net income average growth of -45.60%. Its current revenue year over year growth is -1.63%, higher than its revenue growth of -5.83 for 2010. The fact that revenue increased from last year shows me that the business is performing well. The current net income year over year growth is -43.40%, lower than its net income y/y growth for 2010 of 343.30%. I do not like when the current net income growth is lower than in the past. I look for companies that increase both profits and revenues.
In terms of valuation ratios, SHLD is trading at a Price/Book of 1.1x, a Price/Sales of 0.2x and a Price/Cash flow of 769.2x, in comparison to its industry averages of 2.1x Book, 0.5x Sales and 9.0x cash flow. It is essential to analyze the current valuation of Sears Holdings Corporation and check how is trading in relation to its peer group.
Unfortunately, in terms of valuation per se, SHLD´s perspectives are not good. The company decided to apply cost cutting initiatives rather than improve merchandise mix and customer services to enhance profits. In addition, the company is undergoing increasing input cost, fierce competition and exposure to foreign currency translations. All these factors negatively affect operating performance.
Financially speaking, the company is deteriorating. By the end of the year, Sears is expected to have a lease-adjusted leverage around 8 times (up from 4.6 times at the end of last year) due to a severe drop in EBITDA. The fact that the firm drew down $1.7 billion under its $3.275 billion credit facility to fund holiday inventories after experiencing worse-than-expected profits and cash flows in the first half of the year is concerning.
The near-term liquidity will be reaffirmed by this facility, with a maturity date in 2016 and an undrawn $800 million credit facility at Sears Canada, which matures in 2015, jointly with 120 store closings--expected to generate $170 million, $200 million in inventory reduction, and operating cost cuts.
In terms of figures, EBITDAR/interest expense coverage ratio is projected just over 1.0 times in fiscal 2011 (ending January 2012). By comparison, EBITDAR coverage has declined each year from 4.6 times in calendar 2006 to 2.4 times in calendar 2010. Anyway, the five-year Cash Flow Cushion is above 1 times the base case expense and obligation forecast. A drawdown in inventory is expected to boost free cash flow in the near term.
Now, the credit facility covenants are not something to worry about as the fixed-charge ratio requirement of at least 1.0 is not applicable provided it does not fall below 10%. Sears holds a B+ issuer credit rating, which implies high default risk. Still, the company will not be in default. It has many levers to get out of this financial distress. The firm could consider asset sales or sales leasebacks of its real estate, monetize its popular brands, or sell its stake in Sears Canada.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.