Charles Brandes, chairman of Brandes Investment Partners, is among the most respected mutual fund managers. Brandes has more than 20 years of experience managing equity portfolios, basically picking solid companies trading at attractive valuations.
Charles Brandes is a Benjamin Graham disciple. Brandes consistently applies value investing to all the portfolios managed by the partnership. He seeks to purchase out-of-favor securities that are trading at discounts to their intrinsic values, and then hold them until the market recognizes their true worth.
I found it interesting to take a look at the stocks that Brandes has the most conviction on. I found my information via whalewisdom.com.
My opinion: HOLD
Recently, Hewlett-Packard reported Q2 (Apr) earnings of $0.98 per share, $0.07 better than the Capital IQ Consensus Estimate of $0.91, while revenues fell 3.0% year/year to $30.69 bln vs the $29.91 bln consensus. HPQ is restructuring its business. Hewlett-Packard launched a multi-tear restructuring to fuel innovation and enable investment, expecting to save $3.0-3.5 bln exiting FY14.
While HPQ issued downside guidance for Q3, EPS of $0.94-0.97, excluding non-recurring items, vs. $1.02 Capital IQ Consensus Estimate the market liked the fact that HPQ also issued upside guidance for FY12, forecasting EPS of $4.05-4.10, excluding non-recurring items, vs. $4.04 Capital IQ Consensus Estimate and at least $4.00 previously.
HPQ executed well and delivered to that point a sequential gain in worldwide PC market share and calendar Q1. As a result, it exceeded its guidance in the quarter. Management expects pricing to remain competitive.
HPQ stock started rising pre-market (when the earnings report came) when management expressed a cautiously optimistic tone coming out of Q2. Its results appear to be stabilizing. While the company wouldn't say it has turned the corner, it is making progress. Consumers love the new products. Over the last few quarters Imaging and Printing IPG has been challenged by external factors such as weak consumer demand and natural disasters, but management expressed it is also getting clarity on some of the key actions necessary to continue building on IPG's leadership.
To me, HPQ is a HOLD because it appears to be stabilizing the business, making solid progress in many areas, but hasn't turned the corner yet. Multi-year layoff more of a reallocation of resources and while I believes this is logical, it should take time for desired effect. I liked the fact that HPQ posted solid results gaining 2 pts of share, with improved HDD availability boosting commercial up 3% (at #1 after >10 yrs) helping to offset weakness in consumer (which fell 4%).
I think that given the significant number of moving parts, I remain on the sidelines until I get comfortable with management's ability to post sustainable growth.
Valuation is extremely compelling here and that creates a rise in the stock as soon as HPQ generates a good news event. Shares are so undervalued that any good fundamental news could be an excuse to unlock value. HPQ's shares are currently trading at 5.2x P/E 2012 EPS of $4.07, below the peer group and the S&P 500. HPQ's current trailing 12-month earnings multiple is 4.5x, compared to 12.0x for the S&P 500. Over the last five years, Hewlett-Packard s shares have traded in a range of 4.5x to 18.2x trailing 12-month earnings. The stock is also trading at a discount to the industry average, based on forward earnings estimates.
Bank of America (BAC)
My opinion: SELL
I do not feel comfortable holding any bank in my portfolio. I think that Bank of America exposes my investment to so many risks that I can not understand from a fundamental point of view how to invest in this stock. In a recent article I wrote about George Soros holdings, I explained why I do not like banking stocks.
Recently JMP Securities Capital Markets downgraded BAC. It now expects the shares and earnings of the bulge-bracket names to fall significantly over the balance of 2012 due to a confluence of material events, both at home and abroad, led by an increasingly troublesome situation in Europe. JMP now believe a Greek exit of the Euro is probable (vs. merely plausible in 2010 and 2011) and it fears material damage in the eurozone will result, both directly and via contagion to other PIIGS countries. The U.S. is heading towards a mandated deficit reduction cliff and key market-related tax cuts are likely to soon expire.
While BAC reported relatively good in its last earnings report, I stay on the sidelines. Trading results, and in particular fixed income, were strong and the commercial banking business showed stable revenues and continuing improvement in credit quality.The overhang from the mortgage put-back risk is one of the risks that could appear at anytime and create a new downtrend in the stock.
A bull case for BAC could be that management remains focused on managing capital levels efficiently. The company has been relentlessly trying to realign its balance sheet in accordance with the regulatory changes post meltdown to remain afloat. In fact, Bank of America has been selling non-core assets to strengthen its capital position in order to reinstate dividend hike, meet the new international capital standards
(Basel III), focus on corporate borrowers and U.S. retail clients as well as strengthen investment banking.
In 2011, the company generated $34 billion in proceeds from the sale of non-core assets and businesses, generating 79 basis points of Tier 1 common equity and lowering risk weighted assets (RWAs) by $29 billion. While I appreciate those efforts, I think BAC shares will go down to December 2011 levels caused by continued US risks.
My opinion: I stay away from the pharma industry
While Pfizer could be a great company, I do not feel comfortable investing in both the financial and pharma sectors. They expose me to many risks I can not control. I agree that investing in any stock I am exposed to systematic risks I can not manage, but I think that in these two sectors the other risks get increased. If I would have to select a pharma pick, I pick Davita (DVA), a Warren Buffett selection explained in a recent article.
I like PFE's deep pipeline. Basically Pfizer intends to commit more resources towards the development of treatments in the fields of oncology, cardiology, metabolic disorders, neuroscience, immunology, inflammation and vaccines. Basically, keep expanding its market exposure. These are areas in which the company believes it can take leading positions and ones where Wyeth has some complementary products and research.
The company also said that it intends to stop funding treatments for high risk/low productivity therapeutic areas like allergy, respiratory diseases, urology, internal medicine and tissue repair. The company spent $9.4 billion on research and development in 2011. Pfizer's decision to cut its R&D spend in 2012 indicates its intention to streamline R&D efforts. Pfizer is also dedicating more resources towards growing its biotech business, which I think should generate solid growth for both top and bottom line.
Recently, PFE reported Q1 earnings of $0.58 per share,$0.01 better than the Capital IQ Consensus Estimate of $0.57. I did not like that revenues fell 6.6% year/year to $15.4 bln vs the $15.43 bln consensus. I like to invest in companies that grow both earnings and revenues. The company issued guidance for FY12, forecasting EPS of $2.14-2.24, which may not be comparable to $2.26 Capital IQ Consensus Estimate (prior guidance $2.20-2.30). Management expressed:
"We are updating our 2012 revenues and adjusted financial guidance to reflect our decision to sell the Nutrition business. We remain on-track to finalize a strategic decision for our Animal Health business this year and continue to expect that any separation of that business will occur between July 2012 and July 2013. Further, this quarter we continued to prudently allocate our capital by returning over $3.3 billion to our shareholders in first-quarter 2012, through $1.6 billion in dividends and $1.7 billion from the repurchase of 77 million shares"..
My opinion: SELL
Recently, Pepsico got a big investment from a top value investing firm, Relational Investors. Relational Investors filed a new 13F-HR, showing that it owns 8.98 mil PEP shares, the equivalent of $609 mil or 0.6% of outstanding PEP shares. Later, the WSJ reported that PepsiCo and Relational have had "constructive" talks. Some research houses believe that the confirmation of talks between PepsiCo and Relational and Relational's track record in consumer and large cap increases the attractiveness of PEP shares. To me, PEP is a SELL given poor organic volume prospects (organic volume down 1% globally in 1Q), and lack of an imminent inflection in U.S. beverage volumes.
Recently, PepsiCo reported Q1 earnings of $0.69 per share, excluding non-recurring items, 2 cents better than the Capital IQ Consensus Estimate of $0.67 and revenues rose 4.1% year/year to $12.43 bln vs the $12.39 bln consensus. Constant currency net revenue increased 5 percent, led by double-digit growth in the Europe and AMEA divisions and mid-single-digit growth in PepsiCo Americas Foods. Net revenue benefited from 5.5 percentage points of effective net pricing, offset by negative foreign currency translation of 1 percentage point. While recent report is good, PEP is a very low growth business that has been exposed to lots of management problems.
Considering valuation, PEP shares do not appear cheap compared to the market. PEP current trailing P/E is 15x compared to the industry average of 20.6x. As I explained in an Warren Buffett focused article, I prefer Coca Cola to Pepsico.
My opinion: BUY
I think Petrobras shares are cheap and could experience a material snap-back rally of 20%. I have a positive outlook on Petrobras, thanks to its encouraging portfolio of investments, particularly in Brazil's pre-salt reservoirs that lie below the Espírito Santo, Campos and Santos basins in deep and ultra-deep water.
The company is the operator in most of these exploration areas, and holds interests in them ranging from 20% to 100%. Considering Brazil's huge pre-salt oil reserves estimated at 9.5 to 14 billion barrels of oil equivalent and widely thought to be the most important oil find in recent years, I think Petrobras is in an
enviable position to maintain an impressive production growth profile for years to come.
Another fact that I like is that PBR is becoming more of an international company with exploration fields and investments in many different areas of the world. In fact, the company has been able to successfully leverage its Brazilian deepwater expertise into exploring upstream opportunities abroad, particularly in areas where many other international companies find it difficult to compete. The company has taken its deep drilling technology to the Gulf of Mexico and offshore West Africa, thereby growing its presence in these regions.
Some investors are concerned regarding the company s huge investment requirements, as well as the possibility of heightened state interference and earnings dilution following the $70 billion share sale. I think those risks are already reflected in PBR shares, which are trading at just 7x P/E and a very depressed P/BV in a business that has an acceptable ROE of 8%.
Other stocks that Charles Brandes likes:
Charles Brandes also holds America Movil (AMX) and TE Connectivity (TEL). America Movil is the telco leader in Mexico. I like that and I also like the industry it operates. Despite facing severe regulatory challenges, America Movil continues to dominate the Mexican wireless market through its largest subsidiary Telcel. The company has a strong moat based on its well known brand, extensive distribution network, nationwide coverage and increasing subscriber base.
America Movil continues to benefit from the ongoing migration of voice traffic from fixed-line to wireless and the continued adoption of smartphones, which is contributing to revenue growth. America Movil sticks to its revenue and EBITDA growth projection of 6% to 8% and 7% to 9%, respectively, over the four-year period of 2010 to 2014. The healthy balance sheet performance with cash and cash equivalents of MXN$83.4 billion remains encouraging. The company remains committed to its shareholders through higher dividend payments and share repurchases, a point I assume that Brandes has analyzed.
Brandes also picked a telco company by investing in TEL. TE Connectivity recently reported Q2 earnings of $0.68 per share, excluding non-recurring items, $0.03 better than the Capital IQ Consensus Estimate of $0.65, while revenues fell 2.7% year/year to $3.25 bln vs the $3.3 bln consensus.
I do not like two things about TEL: first, the company is decreasing its revenue growth, and second, management lowered guidance for FY12, forecasting EPS of $2.88-2.98 from prior guidance of $2.90-3.10 and lowering its revenue estimates to $13.5-13.8 bln from prior guidance of $13.8-14.2 bln vs. $13.93 bln Capital IQ Consensus Estimate. Management expressed:
"In the third quarter, we expect sequential earnings growth to exceed 15% due to double-digit sales increases in our CIS and Networks segments and the addition of Deutsch. We anticipate operating margins to be about 14% in the second half of our year."