By Michael McCloskey
I was recently interviewed on the Business News Network - Canada's version of CNBC - and discussed my two favorite picks at the moment: Home Capital Group Inc. (OTC:HMCBF) and Tempur-Pedic International Inc. (NYSE:TPX).
Home Capital is somewhat controversial given the macro headlines regarding a housing bubble in Canada but I believe that the company is misunderstood. Tempur-Pedic is also somewhat correlated with housing but with the stock having sold off 75%, I believe that it is significantly undervalued at the moment. At the time of the interview, Home Capital was trading at $47.25 and Tempur-Pedic was trading at $25.53.
A copy of the video can be found here. A transcript of the interview is provided below:
Business News Network - Market Sense
Wednesday, July 18, 2012 - 5:10 p.m.
Hosts: Catherine Murray (CM) and Randy Cass (RC)
Catherine Murray : In the current headline-driven investment environment finding companies that are not affected by macro issues is certainly a daunting task. Our next guest is looking past the macro and focusing on company-specific fundamentals. Joining us today to discuss the "value" in value investing is Michael McCloskey - President of GreensKeeper Asset Management. Michael, great to have you with us today.
Michael McCloskey (MM): Thank you for having me.
CM: Let's talk about that first in terms of the market and the valuations. How would you term it these days? Because we seem to debate that a lot. Is it actually attractive?
MM: Well I tend to focus on specific stocks. So one at a time. I try to not gauge if the market itself is overvalued. I want to look at specific companies and specific industries. I just look for opportunities. I don't try and predict where the market is going to be over the next 6-12 months. I think that is a mistake that a lot of investors make. I really just try and find good value opportunities one at a time.
CM: So Michael from that perspective though, when you are looking at companies today, on a relative basis today versus five years ago, how attractive are some of the opportunities you seeing?
MM: Well 2008 was fantastic. There were names that were practically being given away. So I would say the market is a probably a little more expensive now then it was then. It is a little more difficult to find names. But I am still finding great names and I am going to talk about a few of them today.
Randy Cass : Every time we have stock-specific guy on who does what you do, who is more bottoms-up not particularly top-down and that means exactly what you have said, the macro environment becomes almost an afterthought. But the situation in which we find ourselves in today, which is Europe could become a big mess as opposed to just a mess at any moment in time. China has a slowing economy, you don't know exactly how slow. The BRIC nations beyond China are a mess amongst themselves. And the U.S., I mean let's not even get into the U.S. right now. How do you not imagine that is not going to impact an impact the stocks you are holding even with strong balance sheets.
MM: I think what that means Randy is we are in for an era of slow growth. Consumers and governments all just have way too much debt. The growth rates that we have seen over the past years are unlikely to continue. I just assume that in that competitive environment you want to own great companies with great balance sheets that can weather the storm and just get through it. And I think that if you are using growth rates going forward that are much higher or equal to in the past I think that is a mistake.
RC: Does the macro environment ever get to a point where you just say "no-mas"? I just have to step aside because of the uncertainty because the risk to the downside is too high?
RC: You would never do that?
MM: For me, no.
RC: You are an investor who will remain fully invested regardless of the macro conditions?
MM: If I am finding quality names to own, that is correct.
RC: Alright let's get to some of those quality names. What's one that you are in right now?
MM: So the first name is Home Capital Group. Just to back up, as a value investor there are three things I look for and Home Capital falls into that category. First I want to buy great businesses. Companies that have very high return on equity and high return on invested capital. And there is something special about their businesses that allow them to beat back competition and earn those excessive returns over time. It could be a brand or a patent, or in Home Capital's case, it is really their OFSI deposit-taking license. Then I want to find companies with management teams who are going to protect my interests as a shareholder. They are not going to use the free cash flow that these great businesses generate to do dumb things with it - buy bad businesses, overpay themselves, dilute me with excessive dilution through stock issues. The final thing I want to look for is a margin of safety. I want to buy businesses so cheap that even if I make a few mistakes and all investors do I am still going to be fine. So if a stock I think is worth $100 I am not interested in buying it for $80 or $90, I want to buy for $50 or $60.
RC: So it is a very Buffett-esque approach ... Ben Graham … So explain to me how the stock has done, when you got into it and where are you expecting it to go.
MM: So Home Capital is a company I know very well. They were an investment banking client of mine in my former career. I purchased this stock at around the current level about six months ago. It hasn't really done much but the company is likely to earn $6.25 to $6.50 a share in earnings this year. It's a fantastic company. They have earned return on equity in excess of 20% for 14 consecutive years. Most companies don't earn 20% on return equity and this one's done it year after year after year.
RC: And the risk of the housing market collapsing for this company?
MM: Right. I think that is why the stock it is priced where it is today. I have heard anecdotally from a few traders that I know that American hedge funds shorting the stock because that is a great way to short the Canadian housing market. It is one of the few ways to get a pure play. The company is a lender to people that the banks in Canada don't lend to. But I think that it is misunderstood.
CM: I was going to go on that front because from a misunderstood perspective as well your other trade that we wanted to get to was Tempur-Pedic and that stock is down about 75% since April. And there is increased competition in that space. How do you feel comfortable in terms of buying it these days?
MM: I think it is a fantastic brand. The company has spent over a billion dollars over the last 10 years on advertising directly to consumers. They are the leader, the worldwide leader - they sell in over 80 countries - in the premium market category. There is a growing populace that is wealthy, not only in North America but also overseas that wants the best. They are one of the best brands in the world in their segment. 80% of the market is innerspring mattresses, dominated by Sealy (ZZ), Simmons and Serta. Tempur-Pedic is by far the largest in the premium segment of the market. They have generated excess returns over time and they have just lowered their guidance. If you have a stock chart that you can put up. The stock goes from $85 down to $22 or $21 because the company was guiding to about $3.80 in earnings this year.
RC: Now part of that guidance is because it has become a much more competitive space. So you would have to imagine competition leads to depressed margins. They can't charge what they used to. They have a lower margin product that has come into the market right now. So how do you extrapolate the valuation when a company is in that much flux?
MM: So the company is dealing with some short-term issues. People have noticed their returns and their competitors say I want to earn some of those excessive returns, unlike the traditional market which is much tougher business. So we are going to start competing in their space. And we are going to get promotional. We are going to pay retailers. Well Tempur-Pedic has the best margins in the business. So they have the dollars they can take and throw at retailers to make sure that retailers and retail sales associates have incentives to sell their beds instead of their competitors. And even if their guidance is high for this year and they are not going to make $2.70, they are going to make $2.20 a share. I bought the stock below $22. I'm paying 10 times earnings for a company that is continuing to grow. They are selling in 80 countries. They still have thousands of distributors and retailers in North America alone that they don't sell through. Their long term goal: 2016 we want to double our sales to $3 billion and our earnings to $8 a share. So maybe it takes a little bit longer and we have to deal with some of these short term competition issues, but I think they are going to get there. I think the stock is worth well in excess of $40 a share. I am very comfortable owning it. I am a customer, I own two of them at home, and I have slept on one for many years and I just think it is a great story.
CM: So from your perspective it is a double from here?
MM: It is.
CM: Michael, great to have you with us.
MM: Thank you for having me.