John Coumarianos: You own three auto companies: Toyota, BMW, and Daimler. Cyclical businesses, capital-intensive businesses. Talk about why you own the auto firms that you do.
David Herro: That's a really good question. And each one of them, in fact, is a little different.
Toyota, in a way, is a recovery story. I mean, they're a little bit out of favor. But underneath, beneath the surface of this being out of favor and making a few mistakes, you have really the leader in green technology. You have the leader in small cars. You have the leader in terms of cost of production.
And at the same time, management is becoming more and more focused on the shareholder. Their dividend payout, their normalized payout, has gone from under 10 percent to over 30 percent. Their return on equity has increased. Their operating profit, from a normal sense, has increased. So they're finally starting to do the things that we think make a company more valuable.
And by the way, all three of the car companies we invested in all have very strong balance sheets, because when you're a cyclical business and you go into a downturn, you need to have a strong balance sheet to make you through it.
Toyota has over 60 billion in net liquidity, in cash and investments. And the industrial operations of both Daimler and BMW are also net cash.
Now, Daimler's another little different story. It is a mix of commercial vehicles--trucks, buses--as well as automobiles. And they have a great global franchise in motor vehicles, in general, a good balance sheet, and they also have some other, non-motor-vehicle-related assets which they have been slowly disposing of.
And the third one is BMW. Now, this is a strict play on the premium-automobile sector. We anticipate them expanding their operating margins. They are doing very, very well in the emerging world. The luxury producers, whether it be cars, or whether it be Cartier, or whether it be LVMH, continue to do very well in the emerging world.
And one of our notions is, instead of paying expensive prices, for instance, for the emerging-market companies, invest in companies that have a lot of exposure in emerging markets. And BMW is a perfect example. And to that degree, so are both Toyota and Daimler.
Coumarianos: Great. You've anticipated two of my next questions, one of which was you made a very bold bet, I think, at the end of '08, beginning of '09, with some luxury goods makers, Richemont in the large-cap fund and Bulgari in the small-cap fund, that have worked out quite well for you. And I assume, since you just mentioned emerging markets, that that's part of the reason for those bets?
Herro: That's part of it. You know what? People did a knee-jerk sell-off of these companies in the second and third quarter of '08, thinking, "We're going into a recession. The consumer is dead. Therefore, we should all sell." Now, remember what value was? Price and quality. They're good-quality businesses, and their price got destroyed. No one wanted anything to do with them, especially when we came to that lousy Christmas season of '08.
However, there are some very good characteristics of luxury-good companies. First of all, they have what Warren Buffett says is a nice moat around them, meaning these are very unique brands. And they're very, very hard to replicate. And as such, what they sell, their end products, earn good margins. OK? So that's one positive.
Number two. The return structure of these businesses, also very good. The return on capital employed of most luxury-good companies is anywhere from 15 to 30 or 40 percent, depending on what it is. So that's another good characteristic.
The negative characteristic is that, yes, in a period of economic slowdown, you might see either negative top-line growth or a lower growth rate per se. So it might either go negative or less of a growth rate.
We think it's far worth it if you could buy these things in the bargain basement. We know, at some point, consumer spending comes back in the developed world. And in the meantime, this whole new growth area, the emerging markets--whether it be China, India, Brazil, Russia, you name it--they are getting good volume increases. Why? Because when people enter the middle and upper-middle classes, they like to demonstrate it. I mean, it was something that an economist by the name of Thorstein Veblen called conspicuous consumption, and people like to do that.
It's good product, it's well-made, and it's got a good brand history behind it, whether it be Cartier, which is Richemont, or Bulgari, or LVMH or BMW or Mercedes.
Coumarianos: Those are hard brands to replace.
Herro: These are hard brands to replace. And our view is, as long as A) they have a balance sheet to make it through the recession, and B) as long as they don't do anything to cheapen their brand, we're in really good shape. And when they're low, you buy them. We did the exact same thing, incidentally, after September 11th. And it was a much smaller downturn, but still... In fact, the prices weren't even as low. And even with the rebound, these stocks still look somewhat attractively priced, so we still hold positions in all these companies.