4 New Ideas From A Top Value Fund

by: FAF Research


Third Avenue looks for good, well-managed companies selling at attractive prices.

Bullish on Comerica: shareholder-oriented management team and inexpensive valuation.

Johnson Controls is misunderstood: upside over the next 12 months.

In this article, we will analyze Third Avenue's new ideas. First of all, it is important to remark that Third Avenue's investment team is focused on finding companies with strong management teams that can deliver long-term shareholder value regardless of macro trends or market movements. This is highlighted in the fund's recent investor letter:

"We buy securities of quality companies at attractive prices. We hold onto them. For a long time. And we don't pay much attention to what markets may do in the interim, as long as our investment thesis remains intact."

Third Avenue is diligent in searching for quality companies selling at attractive prices that can prosper in good times and bad. Martin Whitman, chairman of the fund, explained in the 2006 letter to shareholders that one of the huge advantages of being a long-term investor in well-financed companies is that the strong finances give reasonable competent managements opportunities to be opportunistic, something probably unavailable to most management when they are forced to be supplicants to creditors.

In short, the Third Avenue investment team remain big fans of good, well-managed companies selling for attractive prices, and if market volatility can help out with the latter part, that is fine with them. With all this said, let's move to evaluate Third Avenue's ideas:

Comerica - A Bet on Management Team

Comerica (NYSE:CMA), a bank with most of its operations in Michigan, Texas, California, Arizona and Florida, is a play on its management team and potential shareholder-oriented actions. After shareholder activists targeted Comerica management to boost returns or sell to a larger peer, CMA management team took control of the situation and announced that it hired Boston Consulting Group to advice on strategic initiatives. This shows that the CMA management team is open and dedicated to evaluate opportunities that can accelerate the creation of shareholder value. Third Avenue is eager to hear BCG's recommendations and like the fact that CMA is open to a wide variety of options that should benefit shareholders.

In addition, Comerica is undervalued, trading around 1.1 times tangible book value. According to FBR Capital, Comerica has an enviable low-cost deposit base, asset-sensitive balance sheet, strong credit quality (continued reduction in energy exposure), significant excess capital, and conservative management that is cutting costs in a considerable way.

If rates and loan growth go up, CMA's return on equity will go up too. So, this is a very interesting play from Third Avenue on potential rate increases combined with a shareholder-oriented management team and a solid bank trading at a reasonable valuation.

My recommendation: I like CMA at these levels but consider the overall market in a dangerous position, as almost every stock is actually looking expensive. One compelling idea may be buying CMA and at the same time shorting Financial Select Sector SPDR ETF (NYSEARCA:XLF) in order to capture that relative strength.

Johnson Controls - Poised for Growth

The fund established a new position in Johnson Controls (NYSE:JCI), a stock that Chip Rewley, Portfolio Manager at Third Avenue, believes it is vastly misunderstood:

"There's a lot of misunderstanding about what type of company Johnson is. Many people still think of it as an auto company (because of its history as a maker of car seats and interiors). But the majority post-Tyco merger is a building services company."

The fund likes the merger with Tyco, a leader in commercial fire and security solutions, which is complementary to JCI's operations. The merger is expected to result in around $1B of productivity and synergies over the next three years. Third Avenue's bet here is a multiple re-rating considering that JCI transforms itself into a multi-line industrial company. Right now JCI is valued as an automotive supplier. Auto suppliers are valued lower than industrials because of their lower margins and higher cyclicality compared to industrial companies.

Third Avenue believes that the Adient (JCI's automotive business) spin-off completion will be the catalyst for a beneficial re-rating of JCI to the multi-industrial sector.

My recommendation: The idea looks compelling but JCI is also exposed to overall macro risks and market volatility, which I expect to come after US elections. So, my bet here is waiting to see how Adient trades and have JCI in my watchlist for the next market correction. I won't be a buyer of this stock in this current market environment.

Weyerhaeuser - High Quality Assets and Growth

Weyerhaeuser (NYSE:WY) is one of the fund's largest holdings. According to Todd Campbell, founder of E.B. Capital (independent buy-side equity research), WY is "in the midst of a transition that's expected to drive stronger growth going forward. That transition kicked off when the company acquired of one of its larger peers, creating the undisputed leader in the sector, controlling more than 13 million acres of timberlands". WY management estimates at least $100 million of annual savings from cost synergies, while increasing Weyerhaeuser's exposure to the US South, a region which should benefit as the residential real estate market recovers.

Weyerhaeuser is a well-capitalized U.S.-based forest product company that had been negatively impacted by macro-related headwinds from a decline in demand from China and continued weak U.S. housing markets. Third Avenue likes the fact that management responded with strong measures, such as selling off its homebuilding business and initiating a significant $1.5B share buyback, which accounted for nearly 10% of shares outstanding.

Recently, WY announced an agreement to sell its cellulose fibers pulp for $2.2B and using a substantial portion of the after-tax proceeds from the sale to pay down debt. This should benefit shareholders going forward.

My recommendation: The stock has been moving in a tight range between $30-32.5 since last April. I have WY in my watchlist in order to be ready if the stock starts breaking this consolidation trend and moves higher driven by a specific catalyst. The long-term story looks compelling, but I do not want to take too much risks in this market and prefer to be on the sidelines here.

CBS - Transitioning to an Advertising-Driven Model

Third Avenue likes media giant CBS (NYSE:CBS), a stock that faced investor overreaction to the noise over Viacom (NYSE:VIA) (NASDAQ:VIAB) which has weighed on the value of CBS' stock. UBS Research Team Firm believes that the Viacom deal risk is fully priced in at this point with the news that National Amusements' request on Sept. 29th that merger discussions begin, but without either Redstone (Sumner or Shari) or David Andelman involved in deliberations or voting on the matter. This means CBS Chairman/CEO Mr. Moonves and CNS Board have successfully placed CBS in a strong negotiating position relative to VIAB merger discussions given National Amusements is not currently prepared to either force a transaction or mandate pricing.

Third Avenue likes the ongoing transformation in the CBS business model. "They are taking an advertising driven model and taking it to more fee-driven (which should generate revenue and earnings that are more visible and stable). They should be almost 60% fee-driven by 2018 once they spin out their radio business. And they're in a stock buyback program. And we like the management team, led by Les Moonves." said Chip Rawley, Third Avenue PM.

My recommendation: I like this name a lot and I am waiting to see how the VIAB merger finally plays out. I do not feel comfortable buying before that catalyst because almost anything can happen, despite that CBS seems to have a strong negotiating power in this deal.

Overall Conclusion

Third Avenue looks for companies with strong financial positions, selling at prices that reflect at least a 20% discount from readily ascertainable net asset value (NAV). Most importantly, the company's prospects should look good over the next three to seven years. We have seen this proposition over the different companies highlighted in this article. Certainly, Third Avenue is a prominent value investor to follow.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CBS, CMA over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.