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ValueInvestorInsight-Issue 306 Robotti

ValueInvestorInsight-Issue 306 Robotti

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Value investor insight, whitney tilson
Value investor insight, whitney tilson

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Published by: SheerazRaza on Apr 11, 2012
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Robert Robotti
Value Investor Insight 
Investor Insight: Robert Robotti
Robert Robotti and Isaac Schwartz of Robotti & Company describe the cyclically challenged industries that most inter-est them today, on what they focus when markets go haywire, what overturned their skepticism about investing outsidethe U.S., and why they think Enerflex, Panhandle Oil and Gas, Builders FirstSource and KazMunaiGas are mispriced.
The past three years on Wall Street – notto mention the past three weeks – haverattled even the steadiest investing hand.Have you rethought any aspects of yourstrategy over that time?Robert Robotti:
We focus on smaller-capcompanies that are largely ignored byWall Street and face some sort of distress,of their own making or due to an indus-try cycle. These companies are more like-ly to be inefficiently priced and if youhave conviction and a long-term viewthey can produce not 20-30% returns,but multiples of that. All of that hasserved us well for nearly 30 years and isas true today as it was three years ago, soit would be foolish to change what we’redoing based on some bad experiences thatI believe are way out of the norm.
Many of your current holdings are betson out-of-favor industry cycles turning.Why does that particularly attract you?RR:
It’s a consistent reason why thingsget cheap. We’ll put a reasonable multi-ple on the normalized earnings power of the business over three to four years –knowing it can take five or six – andgiven the types of things we look at oftencome up with intrinsic values that arethree to five times where the stock istrading today.Which is not to say the wait can’tsometimes be painful. Five or six yearsago we thought the manufactured-hous-ing business looked interesting. You hadhomes built in a factory-controlled envi-ronment that delivered more-consistentquality at a lower price, particularly rele-vant as the prices of site-built homes weregoing through the roof. Industry sales inthe U.S. had gone from 370,000 per yeardown to less than 150,000. Industry com-petition had also gotten far more reason-able as the biggest player in the business,Clayton Homes, was now owned byBerkshire Hathaway.Very little has gone right for the indus-try since. First, the financing of site-builthomes entered its craziest phase, whereyou could actually pay less per month fora site-built home because you didn’t haveto put any money down and could get allthe mortgage you wanted. This at a timewhen buying a manufactured home actu-ally required a down payment and acredit check. Then the housing marketcollapsed and new-home building of allkinds fell off a cliff. In 2010 the manu-factured-housing industry delivered50,000 new homes – a higher percentageof total new home starts than a few yearsearlier, but still the lowest number onrecord since the industry began trackingit in 1959.We still believe the industry is wellpositioned when there’s a rebound inhome building. The financing playingfield has been leveled and manufacturedhousing, with its significantly lower per-square-foot costs, should compete verywell for the first-time homebuyer. Therearen’t that many publicly traded playersleft, but our primary holding is CavcoIndustries [CVCO], which has been aconsolidator in the industry and has netcash on its balance sheet.
Is your affinity for energy-related stockssimilarly tied to playing the cycles?RR:
Because there are commoditiesbehind it, there is certainly plenty of volatility to the business and share prices,which we try to take advantage of. Butmore generally it’s an industry I’ve invest-ed in since 1976, so I’d like to believe Ihave somewhat deeper knowledge thanothers that gives me a better sense of when companies are attractively valuedrelative to their assets and the outlooksfor their specific businesses.
Robert Robotti
New School
Bob Robotti's introduction to investing asan independent auditor for client Tweedy,Browne in the 1970s was decidedly oldschool. He'd spend hours talking stockswith Joe Reilly, a firm partner since 1945.Legendary investor Walter Schloss woulddrop in at times when not poring overannual reports in his nearby office.Thirty years later when one of Robotti &Co.'s analysts, Isaac Schwartz, suggestedthe firm make a commitment to investingoutside the U.S., Robotti’s initial responsewas pure old-school. “My English isn’t thatgreat,”he says, “how would we add valuewhen even the language was different?”Spending time in Asia, at Schwartz’sbehest, changed Robotti's mind. Financialstatements were cleaner and more acces-sible than expected, competition fromother value investors was sparse, and thevaluations uncovered from time to timewere shockingly low. Schwartz jumped atthe chance to move to Hong Kong, wherehe spearheads the firm's investments inthe region, now 10% of total assets. “It'seasy to get stuck in your ways and ignoresomeone else's enthusiasm for somethingnew,”says Robotti. “Over time you learnthat sometimes it pays to listen.”
Describe the macro overlay behind yourcurrent interest in several NorthAmerican natural-gas-related companies.RR:
Natural gas is a commodity that’snot easily transportable, so market pricesare dictated far more by local supply anddemand than is the case for oil. For sometime now, the significant increase in gassupply in North America from shale dis-coveries coupled with weak demand inthe aftermath of the recession havepushed gas prices extremely low on anabsolute and relative basis versus oil. Ataround $4 per thousand cubic feet [Mcf],North American natural gas is priced atless than one-third the price of oil on anenergy-equivalency basis.While we don’t expect that discountfor North American gas to go away forthe foreseeable future, we believe the dis-crepancy will definitely shrink. U.S. natu-ral gas has many competitive advantagesversus oil – lower cost, plentiful domesticsupply and far less impact on pollution –which we expect to result in incremental-ly higher demand. At the same time,today’s gas prices provide no return onnatural gas drilling, which will keep pro-duction supply in check. We think that a$6 per Mcf price – 50% above today’slevel – will be needed to sustain drillingthat will be necessary to meet even cur-rent production levels.With $6 natural gas the business envi-ronment for related companies should behighly attractive relative to what’s expect-ed. The changes necessary to get theremay take time – bus fleets don’t switch tocompressed natural gas or coal-fired elec-tricity capacity isn’t shifted to gas-pow-ered plants overnight, for example – butwe consider North American natural gasan interesting decade-long play.
More on that later, but still speaking gen-erally about the types of situations thatattract you, how often are you betting onpotential operating turnarounds?RR:
We’ve been successful in the pastwith a variety of special situations,including companies in bankruptcy orhaving to raise capital through rightsofferings. The challenges facing the com-pany may be industry-related or a resultof its own mistakes. One of our bestinvestments over the past several yearshas been PriceSmart [PSMT], which runsCostco-like warehouse stores in LatinAmerica. It overextended itself and in2005 went through a restructuring, whichincluded a rights offering and bringing innew management. One appealing aspectof the offering was that the founder andlargest shareholder, Sol Price, back-stopped the deal and instead of takingwarrants or special pricing in return,actually offered public shareholders a bet-ter deal on the offering than he and hisfamily got. We unfortunately owned thestock before, but bought a lot more in therights offering at $7 per share – it’s nowcloser to $65.
Do you still own it?RR:
We’ve reduced our position as thestock has done extremely well over thepast couple of years, but we still own it.The company has compounded same-store sales in the mid-teens through therecession and now has 28 stores, mostlyin Central America and the Caribbean,but it still has considerable opportunityfor growth. They’re opening their firststore in Colombia, for example, whichhas a population equal to the currentpopulation base served by the rest of thecompany today.
You’ve made a concerted effort to expandyour international investing [
see box, p.11
]. Describe how that’s going so far?RR:
We’ve focused almost exclusively onAsia, where our style of value investingisn’t in common practice and where,because the markets are even moremanic-depressive, you can find dramaticdisparities between public and privatemarket values. It’s been a wild ride, withthose markets going down more andfaster into the financial crisis and thenup more and faster coming out of it. Ourknowledge base and contacts through-out the region are significantly betterand we continue to find plenty of ideasthat should do very well as theseeconomies continue to emerge over thenext ten years.
Give some examples of the quirky typesof things you’re finding in Asia that fityour strategy?Isaac Schwartz:
We see considerablepotential in Mongolia, whose economy isbeing fundamentally transformed bydemand for its natural resources. Roads,railways and processing facilities arebeing built in the country to facilitate theshipping of coal, copper and iron ore toChina and elsewhere. One way we’vefound to play that is through a Japanesecompany called Sawada Holdings[8699:JP], which owns a majority stake inKhan Bank, the dominant bank inMongolia. Khan’s asset base has grown ahundred-fold in the last decade and itnow controls roughly 30% of the coun-try’s total banking assets.Khan in the first half of 2011 had netearnings of $24 million, a 49% return onequity. Put a 15-20x multiple on that onan annualized basis and the bank overallwould be worth $700 to $950 million,making Sawada’s stake worth maybe$400-500 million. But if we value the restof Sawada’s holdings, primarily a Japanese broker-dealer, at book value, itscurrent market value [at a share price of around ¥740] implies a value for Khan of only $130 million at current exchangerates. That’s a pretty nice discount for acompany with dominant market share,great returns on capital and extraordi-nary growth upside.Another bank bet we’re making isthrough Indonesia’s Panin Insurance[PNIN:IJ], the control shareholder of Bank Panin, a leading commercial bankserving the country’s affluent ethnicChinese minority. There’s actually a bank
Value Investor Insight 
Robert Robotti
We’re focused there becauseour investing style isn’t in com-mon practice and the marketsare more manic-depressive.

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