On October 29, The Wall Street Transcript interviewed Integrity Asset Management Principals Daniel G. Bandi, Chief Investment Officer, Value Equities; Daniel J. DeMonica, Senior Portfolio Manager; and Adam I. Friedman, Senior Portfolio Manager, on investing in value stocks. Key excerpts, including their stock picks, follow:
TWST: Tell about us some of the stocks in your portfolios that you feel are representative of your investment approach.
Mr. Friedman: I think AnnTaylor (ANN) is a classic example. It is a very inexpensive stock and there are numerous catalysts to drive the shares higher. Moreover, we felt that with the Fed easing, we would be entering a more positive investment environment for retailers. The catalysts to drive the shares higher are better merchandising at Loft, upgrading of systems, cost cutting, share buybacks and launch of a beauty line at AnnTaylor Stores for the holiday season.
Mr. DeMonica: Within telecom we like Cincinnati Bell (CBB). The stock is statistically cheap, trading with a free cash flow yield of about 12% on a normalized basis. Some of the catalysts we see are continued margin improvement on the wireless side as well as expanding their data center business, which has good returns. It's also a growth engine that diversifies them farther away from the wireline telecom business, which is facing some secular issues. We think that within the next six to 12 months, we could see share repurchases or a dividend announcement or both as they deleverage their balance sheet down to under 4 times debt to EBITDA and can start to return cash to shareholders. CBB is a great example of where we see a very good valuation as well as some short-term catalysts for the stock to move higher.
Mr. Friedman: Another retailer we favor that we bought in our mid-cap and large cap portfolios in the late summer selloff was Macy's (M). What we saw at Macy's once again was a cheap valuation, 10 times next year's earnings, 0.55 times revenue, and it looked attractive in our valuation models. We saw the following catalysts — an accommodative Fed, a home division improving with the addition of Martha Stewart products and the converted May stores starting to turn around. A few months ago the stock was $45 due to private equity speculation and now we are buying the stock just under $30; we still believe there is a possibility that M could be acquired at substantially higher prices.
Mr. Bandi: Walter Industries (WLT) is another one that we own, and they are a combination coal mining company and home building company. What we liked about Walter initially was that the management really works to enhance shareholder value. Walter used to also own Mueller Water (MWA). We're interested in Walter because the stock's trading at about 5 times cash flow and it was even lower than that when we bought it. When they announced that they were going to spin off MWA, it seemed like management had committed to enhancing shareholder value and that got us excited about the stock. Now that they have spun off MWA, the stock has gotten a lot more attention from investors. Now you've got two pieces of business, which management is committed at some point to separating. You have the homebuilding business. You hear a lot of bad news about homebuilders, but they have an interesting model in that they're site builders, not like a Lennar or somebody that is going out and buying land and then putting up houses. If you're buying a house from Walter, you've already bought the land yourself and you've prepped it to have a house put on it. Essentially you go to Walter and buy the house from them and they come out and put it on your lot. As a homeowner, you've already put a lot of money upfront. In essence a lot of the upfront money that a homebuilder has to put in and where they're losing money, that's spent by the homeowner themselves in Walter's model. That business has actually been doing well for them, I mean particularly relative to other homebuilders, they're doing great. There is also a financing unit that goes along with homebuilding side and that has been doing okay. Their last business is their coal subsidiary and that business is solid. They do metallurgical coal, which is used in steel production around the world. Met coal pricing has been increasing nicely across the world, and so we see the increase in pricing as being a catalyst for the stock and also, looking farther down the road, they will continue to break this company apart, and may ultimately end up just selling off all the pieces to different people. Given the valuation, the trends in met coal pricing, the stability in their housing group and management's commitment to adding value, this should be a winner for us.
TWST: You haven't mentioned any healthcare companies. Do you have anything there that you can tell us about?
Mr. DeMonica: Within health care, one area we've been focusing on across the board is the life science research companies — companies that manufacture the machines and the consumables used in scientific research labs. The group has had a nice run and we have owned them across the board — Varian Medical (VAR) namely within small cap, and Mettler-Toledo (MTD) and PerkinElmer (PKI) within our mid-cap portfolios. They are benefiting from worldwide growth in setting up labs in China and India in particular and don't have the reimbursement risks that a lot of the domestic healthcare companies have. That's one trend in health care.