Wed, 23 Apr 2014
Comanagers Charles Pohl and Diana Strandberg are discovering growth advantages for certain players in the semiconductor and mobile data spaces, particularly in emerging markets.
Laura Lallos: Hi, this is Laura Lallos, a fund analyst here at Morningstar, and we have here with us today Charles Pohl and Diana Strandberg from Dodge & Cox. Several Dodge & Cox funds were nominated for Morningstar's Manager of the Year Award last year. They had a great year, and we're excited to catch up today. Thank you for coming.
Diana Strandberg: Thank you for having us, Laura.
Lallos: Obviously last year was a great year for all stock investors, particularly for the Dodge & Cox Stock investors. Some people may be wondering, particularly value-oriented investors, are there any values left in this market. And you are finding them. One area I understand, you are finding them is in the technology, media, and telecom space.
Strandberg: That true. I'd say across the globe, valuations are more reasonable today, and so they certainly have come up at reasonable levels around 14 to 16 times earnings in general in the developed world, depending on where you are, and probably about 10 to 12 time earnings in the emerging markets, depending on where you are, so quite reasonable today.
Where we see opportunities today across the globe is expressed in where we have overweights relative to the market in our portfolio, so tech, media, and telecom would be one area that we see a lot of investment opportunity, in technology in particular. In the U.S., we see opportunity in Internet and software companies. Internationally, we see opportunities in Internet and media, as well as telecom-equipment companies in particular.
We also have overweights in health care in the U.S., both in pharma and more recently in health-care services, where we see long-term growth at a very reasonable price. And more recently, we have been building positions in oil services in our domestic, international, and global portfolios.
Charles Pohl: We remain underweighted in utilities and consumer staples, both of which are still comparatively expensive because I think investors post-2008 have been attracted to things that were perceived as less economically risky and more stable, and the prices of some of those securities are up to levels where we don't think the returns have been as attractive. That may have changed a little bit with consumer staples over the last year, but they are still priced at a premium.
Lallos: Maybe we can start by following up on technology for example. Some of the names of course have been in your portfolio for years, like Microsoft. You added Samsung recently on the international side. That's a name that's in the headlines because of ongoing litigation with Apple. Maybe you can talk a little bit about how you factor that kind of external risk into your analysis?
Strandberg: Samsung is a Korea-based smartphone and consumer electronics company. They make DRAM components, as well as handsets, among many products that they make. We have followed Samsung actually for quite a long time. We've had meetings with managements, we have financial models, but as you pointed out, accurately in the third quarter last year, we started a position in the company for the first time.
What we see and how we think about some of these news items is that there is a lot of concern right now about the handset business at Samsung. And that concern whether it's because of recent litigation or the potential for competitive pressures to erode their high profitability, for example, we think have depressed valuation of the company, it's about seven times earnings. It trades at less than 100% of sales, the market cap of the company. They're net cash, have a high return on capital, and are profitable.
Pohl: One thing that's also interesting is, while we don't believe that the handset business has as grim prospects as it is discounted in the market, there is another side of the business, which is the semiconductor business, and particularly in the DRAM part of the business, where you've had historically a lot of competitors and very cutthroat competition, very low profitability in that business. There has been a huge consolidation to where you're really down to three players left in that business. So the entire industry structure has changed, and the biggest one is Samsung.
The potential going forward for them to be able to earn a decent return in that business, we think has greatly improved compared with history. So investors may be missing that part of the company and may be a little too obsessed about what's going on in the handset part of the business.
Strandberg: That's exactly right. Their position in semiconductors and components, we think is something that provides sustainable growth, profitability, and actually underpins the valuation of the company to the point where we don't think that the handsets are quite as dire as other investors seem to think but where you can take a lot of pain there and still be OK as investors.
Pohl: This is a company, too--we just had a team of people over there two weeks ago--and it's a company that the management team is very long-term-focused and very aggressive. It's a tightly run, very competitive, aggressive company. We take some comfort from that, as well.
Lallos: Why don't you talk a bit about the significance of growing emerging-markets demand for some of these products? I know we've spoken about this with Microsoft and how that improves the prospects for the company.
Pohl: Well, one thing with Microsoft--and we were just discussing it a few minutes ago here with you that's interesting--is that more than half of their product is stolen, and a lot of that is stolen in the emerging markets. And so, there is potential for them to reduce that. You see in some of these countries, they're beginning to take intellectual property a little more seriously. And so that helps that situation.
Also, a move to software-as-a-service, a move to the cloud-based computing, potentially can help them because it's harder to steal the product. It's easier to steal a packaged product and make a one-time copy of a program. It's harder to steal it as a service. And so that potentially helps them over time, as well.
Strandberg: One of the things that is running through [Dodge & Cox International Stock] and the [Dodge & Cox Global Stock] portfolio today, as we think about future growth areas, mobile data is an area that we've talked about in the past, in terms of people being able to bring their world with them. And in the emerging-markets in particular, we think mobile service providers will be the broadband service providers, most likely. We have an array of wireless-service-provider companies that serve our domiciled markets or serve emerging markets. In the portfolio, Millicom would be an example; MTN would be an example, a South Africa-based wireless service company.
We also have a number of companies, one of which we were able to start in the portfolio in May of last year when emerging-markets valuations fell pretty precipitously, Baidu, the Chinese search company. And this is a company that we had been covering for some time. We owned Google starting in August 2012. We've long owned Naspers, the South Africa-based media company that has a 35% stake in Tencent, a Chinese Internet company.
So we had a lot of knowledge about the business. And when that valuation became attractive, we were able to quickly move, bringing that thorough bottom-up research to bear with that long-term view and initiate a position in Baidu. There are a lot of different investments that we have, some domiciled in emerging markets, some domiciled elsewhere, that are benefiting we think from the growth of mobile data in the developing world.
Lallos: And Baidu is an example of a name that hasn't taken three to five years to pay off.
Strandberg: Yes. We are three- to five-year investors, but if a stock insists on performing fabulously in a shorter time frame, we're OK.
Lallos: Your energy stake overall is fairly low, but oil services is an area that you've been enthusiastic about, and adding to, and adding new names to.
Strandberg: It's true. The valuations are reasonable today. And some of the things that we think give us some optimism about the long-term growth opportunities is, as we talk to their customers, the integrated oil companies, not only just the publicly traded ones, some of the nationally owned oil companies, they need to replace production which depletes typically 6%-8% a year, and that oil is typically in harder-to-find geologies, sometimes in hostile geographies, as well. The oil-service industry has consolidated significantly and made significant investments in technology, which we think then their customers need them more. There are fewer of them and they are bringing more to the table.
Pohl: One of the things that you see is that the discovery of new large fields, new large oilfields has been declining for a number years. The reason that production hasn't declined is because the recovery rate, the amount of oil that you get out of an existing field, the percentage that's actually able to be pumped out of the ground, has been increasing. A lot of that is due to new and better technology and being able to get that recovery rate up. That technology often resides with the oil-service companies.
And then a second aspect that's quite attractive to them versus the integrateds is that a large portion of the world's reserves now are controlled by state-owned entities. In Mexico, Venezuela or Saudi Arabia, the major oil companies are not participants in that market, but those national oil companies of those countries in many cases very badly need modern technology in order to effectively exploit the resources that they have, and they can bring in then the oil-service companies to perform those services. It's politically possible, whereas bringing in a major oil company is viewed as an impingement on a country's sovereignty in some cases, and so that can't really happen. And so, the oil-service companies have that advantage as well versus some of the oil majors.
Lallos: And what are the newer names that you've added there?
Strandberg: We've long held Schlumberger and Baker Hughes, and we recently added Weatherford in the portfolio and Saipem.