Jason Stipp: As a value investor when you are going out and looking for opportunities, have you found that your opportunity set is smaller today because we have seen the markets continue to go up? And also in your portfolio, how much more room to run for some of your favorite names do you think you have?
Bob Olstein: First of all obviously from March 2009 to today, the portfolio is up 125% of the bottom. There are less values and the discounts are not as great as they were at the bottom of the market.
Now, if we value companies not only off their free cash flow, but of the alternatives, which is 10-year Treasuries. 10-year treasuries are still at a 3% rate, and we always put a 1% fear factor in there, and now we're paying off 4% Treasuries and we're still finding 20%, 30%, 40% discounts in these smaller companies, which have more risk, and 15% discounts, as I said in your larger, well known cap companies.
And... and then looking at the earnings, were bottom-up type of players--but if you look at the S&P earnings of estimates for next year of $105 a share, and we think the appropriate multiple in this interest rate environment for the market is somewhere around 15 to 16 times, we're finding the market somewhere in the 10% to 15% still undervalued, not 50% anymore. But we're not market players, but we have sell discipline. Every stock in our portfolio has a prenuptial agreement. When it reaches our full value, it is sold and that's critical and usually we never ... unfortunately we always sell early.
Stipp: I wanted to talk to you a little bit about some of your individual holdings. You mentioned Microsoft earlier. Microsoft, obviously, a big-cap company, is followed by a lot of people. What do you think you're seeing in Microsoft that other people aren't seeing in a company?
Olstein: There is a mania for growth. There is a mania out there today of immediate gratification. Here is a company that has got a 10% free cash flow yield; yes, their growth rate is no longer double-digit; yes it may only be 5% a year, but investors out there are paying 50 times earnings for ARM, okay, and so we look at price, price, price.
ARM's growing faster, much faster than Microsoft. Microsoft is not going to disappear. They can retire this company, take it private if they want with their free cash flow in 10 to 11 years, and we basically think that we're getting a company that is probably somewhere between 25% to 30% undervalued, and we're willing to wait two to three years to realize that value and not take the risk of buying a 50 times earnings company.
Stipp: In retail, you also own Macy's. Department stores, during the downturn especially, seemed to struggle quite a bit. Macy's, I think, recently had a pretty good quarter. What are you seeing in Macy's, and what's your conviction behind that name?
Olstein: We were fortunate to buy Macy's down when the stock was $10, $9, $8. We started probably at $15 or $16, and there were some hidden earnings in Macy's or I should say hidden free cash flow. At the bottom, this company reported a dollar. They have outstanding management who went from a national distribution system, saw it wasn't working, and you know about the big fight in Chicago with Marshall Field's, and they went and they converted all of their stores to 25% was based on local merchandise, not just the national merchandise.
In addition, here was a company that made a major acquisition and had amortization and depreciation far above their capex. So, when they reported a $1 a share in the depth of the recession, they reported $2.50 of free cash flow because depreciation was so far above capex. So, we bought this company for four times free cash flow.
They are going to report this year $2.45 in GAAP earnings, but there is still another $0.70 in cash flow above the GAAP earnings. So we are buying this company at even at $28 today--we're not buying it, we still own it, it's one of our largest positions. At nine times free cash flow, or eight times free cash flow, and we are getting a 12.5% free cash flow yield, we think this stock is worth somewhere in the high $30s. We've made a triple already, and we expect to make another 30% to 40%.
Stipp: Last name I want to touch on is in the consumer area, Dr Pepper Snapple. This is a company where were some of the brands are not the Coke's and the Pepsi's of the world, but what are you seeing in that particular name and why was it attractive to you?
Olstein: We started buying Dr Pepper in the high $20s. This was a spin-off from Cadbury, and it was a stepchild. Here is a company that has Dr. Pepper, Crush, Canada Dry Ginger Ale, Mott's Apple Juice, Snapple. Coca-Cola and Pepsi just paid close to a $1.5 billion to distribute their brands, very underutilized, underdistributed, they are nowhere in Europe yet. We see free cash flow of close to $3.50 a share in a couple of years. We think this company can grow at 5% a year. They haven't even come close to taking advantage of their brands at this point in time. Even though the stock has moved 50% for us, we think the stock is probably based on its free cash flow worth in the mid $50s, and we think Coke and Pepsi agree with us. They've already made major distribution investments in this company, and of course the analysts are worried about commodity costs in the short run and everything that bothers a company on a day-to-day basis, and we just see tremendous long-term value here.