I like to study what portfolio managers do with their portfolios. I think it is essential to invest in solid companies that generate strong results. Reading only the financial reports for a company is not enough to justify an investment. It is essential to understand the whole business. I also pay attention to each company's future prospects and its management capability.
Bruce Berkowitz is one of the most followed portfolio managers, so I think it would be interesting to study his holdings and provide my opinion about each stock he invested in. I was able to access his portfolio via Whalewisdom.com.
American International Group (AIG)
Recently, American International Group reported Q1 earnings of $1.65 per share, $0.74 better than the Capital IQ consensus estimate of $0.91. AIG shareholders' equity totaled $103.5 billion as of March 31, 2012. I think that the most important point was AIG's book value growth. Its book value grew approximately 8% during the first quarter to $57.68 per share. AIG also reported strong liquidity numbers. AIG parent liquidity sources amounted to approximately $12.4 billion as of March 31, 2012.
After the earnings report, Deutsche Bank raised target on AIG to $40 from $35 because the firm believes that AIG is likely to buy back far more of its own shares than the market price would indicate. The firm also believes that those share buybacks will happen faster than expected. Finally, Deutsche Bank believes $15-$20 billion (or even more) worth of buybacks over the next 12 months is achievable as the Treasury and AIG sell off the remaining non-core assets. Deutsche projects that book value per share growth in excess of 30% is possible if shares continue to hover around their current price.
In terms of valuation, shares are undervalued. Currently, AIG trades at 10 times 2012 consensus EPS estimates, a multiple that is similar to the 9.7 times industry average. On a price-to-book basis, shares trade at 0.6 times, which is a 25% discount to the 0.8 times industry average.
I think that AIG is an interesting pick but its financials are very difficult to understand. I prefer to focus on companies like Apple (AAPL) or Coca-Cola (KO), which seem more predictable in terms of earnings and revenue growth.
Sears Holdings (SHLD)
Sears is a turnaround play. The company recently reported results that surprised the market. Its Q1 loss of $0.31 per share was less than the Capital IQ consensus estimate of -$0.65, while revenues fell 2.8% year over year to $9.27 billion in comparison to the $9.26 billion consensus. Sears' domestic comparable-store sales declined 1.0% in the first quarter of 2012, while Kmart's comparable-store sales declined 1.6% and Sears Canada's comparable-store sales declined 6.3%. Additionally, the company announced that its board of directors has approved plans to pursue a partial spin-off of its interest in Sears Canada.
Its earnings numbers were driven by the ongoing cost reduction, inventory management, and improved liquidity strategies that management is implementing. The company's first-quarter adjusted loss of $0.65 per share narrowed from the year-ago quarter's loss of $1.34. Moreover, adjusted EBITDA margin expanded 150 basis points to 2.1% from 0.6% in the prior-year quarter. Sears has long been grappling with sluggish top-line performances and even weaker bottom-line results. However, the measures undertaken to revive the operating performance are showing some signs of improvement as evident from the company's margin expansion and narrower loss per share from the prior-year quarter. Apart from this, Sears has been focusing on improving margins through leverage on buying and occupancy expenses. I believe that a reduced stake in Sears Canada will strengthen its liquidity position while boosting its future growth prospects.
I think that Sears could be a great turnaround opportunity for value-oriented investors.
Bank of America (BAC)
The current environment is not the best for the banking sector. The yield curve is collapsing, and considering that banks still generate anywhere from 50%-70% of their revenues from net interest income, large banks may be at most risk for revenue pressure if the current environment was to persist. I would avoid investing in Bank of America.
One positive for Bank of America, however, comes from its management capabilities. Its management remains very 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 meet the new international capital standards (Basel III). 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 by $29 billion. I agree with these measures because they make the company's balance sheet stronger.
On a price-to-book-value (P/BV) basis, shares look undervalued. But I have no clarity on how to correctly read the company's financials. Bank of America shares currently trade at 12 times consensus earnings estimates for 2012, an 8% premium to the 11 times for the industry average.
I do not recommend investing in Bank of America at this time.
CIT Group (CIT)
I read an interesting report from Stifel Research explaining how undervalued Cit Group shares are. Basically, the Stifel analyst believes the recent sell-off in CIT shares is overdone and views the current depressed valuation as a compelling buying opportunity. In the analyst's view, the market has soured on CIT due to misconceptions about its risk profile -- especially its wholesale-funded business model. On the contrary, CIT is a very different story post-bankruptcy and Stifel thinks the stock is poised to revalue much higher as fears fade and progress gains momentum. Similar to other financial picks from Berkowitz, it is not easy to read and understand the financials of these types of companies.
Recently CIT reported bad numbers, which created a downtrend in the stock. CIT Group reported Q1 loss of $2.22 per share, $0.64 worse than the Capital IQ consensus estimate of -$1.58. One good point came from the lower provisions. The first quarter provision for credit losses was $43 million, compared to $122 million in the year-ago quarter and $16 million in the fourth quarter. The decrease from the prior-year quarter reflects improved portfolio credit quality, including a reduction in specific reserves, and the continued reduction in non-accrual loans. The sequential quarter increase in the provision is primarily due to the establishment of reserves for commercial asset growth. CIT also remains well capitalized. Its preliminary tier 1 and total capital ratios as of March 31, 2012, were 17.6% and 18.5%, respectively, down from 18.8% and 19.7%, respectively, as of Dec. 31, 2011, but still very high and well above the regulatory requirements, which shows that CIT emerged from its bankruptcy implementing a much conservative financial strategy. I expect the company to continue building capital over the next couple of years.
Regarding valuation, CIT shares currently trade at a price to book value of 0.9 times, a 64% discount to the industry average of 2.5 times. CIT valuation on a price-to-book basis looks attractive given a trailing 12-month ROE of 1.5% vs. the negative industry average.
I believe that Berkowitz understands the financial industry very well, but I cannot recommend this stock even if it looks undervalued and conservatively risk-managed.
Leucadia National (LUK)
New York-based Leucadia National is engaged in manufacturing, oil and gas drilling services, gaming entertainment, real estate activities, medical product development operations and various other investment activities in the United States.
Its businesses are substantially influenced by the general economic conditions. Businesses including real estate, manufacturing, oil and gas drilling services, and gaming entertainment were adversely impacted from different economic downturns. I think shares are very risky in the current macro environment. I prefer to pass on this Berkowitz pick.
The shares trades at a P/E of 10.6 times, compared to 15.6 times for the peer group and 13.6 times for the S&P 500.
Other Stocks Berkowitz Likes
I do not like St. Joe. The business is facing several internal problems that make me uncomfortable investing here. St. Joe reported a Q1 loss of $0.01 per share, $0.04 worse than the Capital IQ consensus estimate of $0.03, while revenues fell a whopping 58.4% year over year to $30.5 million.
Management said the following:
We are continuing to reduce expenses and evaluate our assets for revenue and growth opportunities. We believe that our current cash position and cost structure provide us with the ability to hold or opportunistically reposition our assets to create additional shareholder value. We intend to continue to invest in those projects that we believe will meet our risk-adjusted return criteria such as our holdings in Venture Crossings at the Airport, the Port of St. Joe, Breakfast Point, our primary home community in Northwest Florida, and Rivertown, our primary home community in Northeast Florida.
MBIA's reported Q1 liquidity should be enough to cover expenses related to litigation resolution as it tries to recover some of the losses ($3 billion) related to the Bank of America/Countrywide mortgage bonds it had guaranteed. If MBIA wins the Article 78 case, this will be a positive headline for the company. However, I find it extremely difficult to understand MBIA's business, so I do not recommend investing here.