Thu, 10 May 2012
FPA's Eric Bokota discusses his recipe for finding value in Europe for his new fund as well as why he's cautious of putting money into Asian names.
Christopher Davis: I'm Christopher Davis, a senior fund analyst with Morningstar, and I'm here today with Eric Bokota. He is a comanager of FPA International Value, which launched last December. He is an alumnus of Oakmark International Value. He was one of the analysts there along with his comanager at FPA International Value, Pierre Py.
Well thanks for joining me today. I appreciate it.
Eric Bokota: Thanks for having me Chris.
Davis: FPA is well-known for its strong value orientation. They are absolute-value investors, meaning they are looking for stocks that look cheap, of course, on an absolute basis. Can you talk about how your approach to value fits in with FPA's overall?
Bokota: Sure. We are value investors, so we are looking to buy businesses at significant discounts to what we believe the fair value of those businesses are, but beyond just looking for businesses that are cheap, we have a strong bias toward buying high-quality businesses. And by that I mean businesses that have strong competitive positions, that generate good margins and returns on capital, and that have management teams that run the business well not only from an operational perspective but also that allocate capital in a manner which creates value for shareholders over the medium and longer term. We focus only on businesses that have strong balance sheets and good cash flow generation profiles, and are only interested in investing and we can buy in at a 33% or greater discount to our estimate of intrinsic value.
Davis: With your cohorts at FPA, when I think of the firm's CEO, Bob Rodriguez, he is kind of known for having a relatively pessimistic outlook on the economy. He's very worried about government debt in the United States and across the world, especially in Europe. And if you look at your portfolio, it's overwhelmingly titled toward European investments. Could you talk about how you incorporate macroeconomic concerns, big-picture concerns about the economy and your investments in a troubled part of the world?
Bokota: Sure. We certainly share many of Bob's concerns about the macroeconomic environment in Western Europe. Although our portfolio is heavily tilted toward companies domiciled in Western Europe, I think it's important to understand that many of these are global businesses and that more than 50% of the free cash flow of the portfolio of companies that we have is coming from outside Western Europe. So, while the businesses are domiciled in Western Europe, these are truly global enterprises.
The way that we incorporate the difficulty that we're seeing in Western Europe is in two ways. Firstly, the way that the assumptions that we make regarding the future free cash flow generation of the companies is that we have fairly conservative estimates reflecting the difficulties, not only in Western Europe but really throughout the developed world. Secondly, because there are concerns about the financials sector in Europe, we see that there could be systemic risks in the region. And it's very important for us to buy companies that have strong balance sheets that we're convinced will not only weather the storm in a very harsh economic environment, but that will ultimately emerge stronger. So, the businesses that we own have low levels of financial leverage and don't have significant refinancing needs over the near and medium term.
Davis: One thing that you see on the FPA website is one of its credos is this belief in saying "no." And in terms of "No, I'm not going to invest in it; it's too expensive," or saying "yes" to owning cash because you can't find stocks that meet your value criteria, what are you saying no to? What's too expensive, or what's too dangerous?
Bokota: We're saying no to a fair amount of things as you can see by our 34% cash balance at the end of the first quarter.
Davis: And I noticed that you have fewer than 30 stocks.
Bokota: That's correct. We run an absolute-value portfolio, so we're only interested in investing in asymmetric opportunities, where we can buy high-quality businesses, selling at significant discounts to our estimate of intrinsic value, and we are very concentrated. So, we don't expect to own more than 25 to 35 names. The concentration is really an output of being so focused on buying something that's both high-quality and selling at a significant discount. We only buy businesses that lend themselves to appraisal.
One of the things I've noticed is that you don't see us have meaningful or any exposure to financial institutions and that's a function of two things. First, these businesses have an inherently high level of financial leverage. And secondly, our process is very focused on research and really understanding the economics of the business and the fundamentals of the business. Given the black-box nature of many of these financial institutions, we don't feel that we can be comfortable in really understanding what the value of these businesses are, so we haven't become owners in any of these businesses.
Davis: In addition to financials, one thing that I do know that when you were at Oakmark, you covered a lot of Asian stocks, but when you look at the [FPA International Value] portfolio, there's not much at all in Asia. So that's an area you're saying no to, as well?
Bokota: That's true; that's interesting. I did spend a number of years covering Asia and a lot of time covering Japan. From a valuation perspective, Japan looks very attractive as it sells at low multiples of price to book value and low multiples of enterprise value to earnings before interest and taxes. And really the commonality there is that the reason these multiples are depressed is because cash has piled up on the balance sheet as companies have not distributed their retained earnings.
The problem that we have with investing in these companies despite their apparently attractive valuations is the lack of alignment between management/board of directors and shareholders. The problem is that management is simply not incentivized to take actions to create value for shareholders, which is why you've seen the cash pile up. So, while there's a lot of well-positioned companies that have globally competitive positions, they don't meet our standards of having management teams which create value. That said, we have identified several high-quality businesses in Japan, which do run the business well from a capital-allocation standpoint. Sadly, they are not cheap enough for us to buy at this time, but it's possible you could see us become invested over the medium term.
Davis: I know a lot of investors are focused on China. There are a lot of things going on there just from a political standpoint; investors are worried about falling economic growth there. But I just wonder if you really have a problem there of misaligned incentives between management and shareholders, especially when the managements are so closely connected with the government?
Bokota: That's absolutely the case that we see in China. For many of the Chinese-listed companies you have large owners that are government-affiliated, and we don't have transparency into how decisions are made and whether management's objectives are political objectives or to create value for shareholders. Without that level of transparency, we don't have the comfort to invest in these shares. But we are able to participate in China's economic growth through our exposure to global companies, and Daimler is a great example as China is one of its largest markets.
Davis: All right. Well thank you very much for your time.
Bokota: Thanks for having me Chris.
Davis: I am Christopher Davis with Morningstar.com.