Shannon Zimmerman: Let's talk about ExxonMobil, which is more of a sort of classic large-value holding, yet [Legg Mason ClearBridge Equity Income Builder] an equity-income fund and relatively buttoned-down. That’s the way that [ClearBridge manager Hersh Cohen managed Legg Mason ClearBridge Appreciation], as well. ExxonMobil obviously has economies of scale that are enormous, but still it's tethered to the price of a commodity. How do you get comfortable having that as a top holding?
Michael Clarfeld: Yes, that's a great question. Let me start with a little bit of big picture on how we invest and types of things we look for, and then drill down on ExxonMobil. I think you're exactly right that generally speaking given our approach, which is this high-quality bias and the idea of investing in companies that can compound returns predictably year-in, year-out, things with lot of cyclicality--and particularly deep commodity exposure--generally don't fit that bill. So, you wouldn't see us be really large in a metals company particularly or something where there's a lot of volatility.
We think oil is a little different, for a couple of reasons. Number one, the actual demand for oil tends to be less cyclical, than demand for other commodities. So, if you look at steel demand for example, steel demand is predominately driven by construction in China right now on a global basis, and there are lots of other things. But that’s actually probably the single biggest driver. And that's actually somewhat a very cyclical thing, I mean construction in China could go up a lot and could go down a lot. The real demand drivers for oil, the largest single one is cars being driven on the road, and that actually doesn’t change that much with the economy. We think oil is different than lot of other commodities and that its usage pattern is less cyclical.
I think the second thing we’d point out is that we continue to believe that oil is structurally attractive for sort of the foreseeable future. The reason for that is it has become harder and harder to find new oil in the world, and generally speaking when we do it's in more and more expensive places, so it's deep offshore, and these are environments where because it's more expensive and because it has a higher cost of production, it means that it’s going to support a higher oil price. That’s on the supply side.
On the demand side, we see emerging markets, again particularly China, where you see people embracing products that use oil in a way that's never been done before. If you look at the amount of cars in the road in China, it’s growing exponentially. We have a tight supply situation, where we think supply is structurally tight. We believe this is a commodity that is actually less cyclical than most other commodities, and then we see a secular growth story based on emerging markets. Those three things together make us comfortable with sort of an oil play.
Then we look at ExxonMobil; we believe ExxonMobil is the best in the space. It's incredibly well-capitalized. It has a AAA balance sheet, one of few left in the world.
Zimmerman: Where it really does pay, it is a huge advantage to be huge. Right?
Clarfeld: That's exactly right. Many of the more attractive places where it's finding new oil are in very hard-to-reach, hard-to-exploit areas. And number one: having the size of the balance sheet--many of these are multibillion dollar projects, you have to be a big company to play--and number two: being able to draw on the talent base it has to exploit it, Exxon is really a better operator we think than most others.
Zimmerman: How do you buy a company like ExxonMobil well, though? So this is an investment thesis. So everything you’ve pointed out, makes sense in terms of them being a dominant player and a best-in-class player in the energy industry, but what about valuation? What does the valuation work look like on a company like ExxonMobil?
Clarfeld: It's a good question. Right now where things are, ExxonMobil’s trading in the low-double-digit multiple of earnings and cash flow, call it anywhere from depending on the day 10 to sort of 12 times. Given our view on oil--we expect to see a stable to rising price deck for oil for the foreseeable future--we think it’s a very reasonable place to be.
If the valuation were substantially different, if we're at a high-teens multiple based on our current oil assumptions, we would have very different view. But given that we have oil assumptions that we think are reasonable going forward and that based on those assumptions it’s trading at a reasonable price, we feel very comfortable being invested at these levels.