Kevin McDevitt: Hi, I'm Kevin McDevitt, and we are here at the Morningstar Conference with Harry Hartford from Causeway International Value. Terry thanks for joining us.
Harry Hartford: Thank you very much, Kevin.
McDevitt: After this phenomenal run we've had the past five years, are there any contrarian opportunities left out there these days?
Hartford: There are a few. They are fewer in number today than certainly four or five years ago, but there are a few. I think one area that has a certain amount of appeal probably, not when you overstay your welcome, are airlines. We've filled a position in the former British Airways, now IAG. As you know airlines have been a fair graveyard for a lot of investors, and I think it's important to understand that we've been presented with a window of an opportunity to rent a couple of airlines globally as a consequence of the consolidation that we've seen and much better capital allocation, capital discipline. And as they say about transportation, specifically in airlines, it's a contrarian area that value investors probably have had difficulty with in the past.
McDevitt: Do you think they'll get some pricing power now because of that consolidation, and because of perhaps better capital allocation, too?
Hartford: I think they have some pricing power. I think what's more important from their perspective is that the load factors remain high. In that context, the plane is taking off one way or another, and if we can get more bodies onto the plane, it's that load factor. And the load factor obviously is helped by an absence of capacity growth. There is some capacity growth in the low-cost airlines, particularly in Europe. So we're mindful of that. But for the three hub-and-spoke carriers in Europe that are left, they certainly do have some pricing power in specific routes that they have historically served and it's the lack of capacity growth. And at least until fairly recently oil prices have been quite supportive, and fuel being a big component.
Obviously airlines are buying more fuel-efficient aircraft. I don't think fares are falling commensurate with the improved efficiency associated with the newer aircraft. So the yield effect as a consequence is also higher.
McDevitt: When you think in terms of airlines and the growth in air travel, emerging markets inevitably come up, and two other fairly new additions to that portfolio are Nikon and Unilever. It seems like those are also two positions that will be impacted by emerging-markets growth, which has teetered a bit in recent quarters. What's your thesis for Nikon and Unilever, and how dependent are they upon emerging-markets growth?
Hartford: I think Unilever [is dependent on emerging-markets growth] more so than Nikon. The investment thesis around Nikon is essentially that the single-lens reflex camera market will show signs of recovery. Now Asian markets are important. The Japanese market is an important one for a single-lens reflex camera, but excluding that, the growth in the rest of Asia will certainly be a contributing factor. But the investment thesis is definitely one that requires the camera market, and the lens market, in particular, to begin to recover.
We think that in addition to that, particularly in Asia, a rising middle class will be supportive of increased demand as a consequence of the higher consumer expenditure. So as consumers gravitate from the iPhone or the compact camera to more sophisticated cameras, it's essentially a two player market. You've gotten Nikon and you've got Canon, and that's it. All the others, for all intents and purposes, dropped out. So it's a well-consolidated market, and a natural consequence of that is that a pickup in demand will benefit essentially two companies.
Unilever on the other hand, yes, you're right, particularly in mid- to late 2013, those consumer stocks in the developed world with exposure in the emerging world fell or performed quite poorly. An element of it I think stemmed from the fact that those companies have significant emerging-markets exposure. Emerging markets in general traded down as investors were concerned about higher bond yields here in the United States.
That was what I would describe as a great example of the integration of the world economy today. Higher bond yields in United States have a material impact on capital flows. Those capital flows affect the developing markets to much greater extent. As capital is being withdrawn, the developing markets traded off. While those companies in the developed world with the greatest amount of exposure to developing markets, in general they tend to be consumer-oriented companies, traded down in sympathy.
And that afforded us an opportunity to acquire a modest interest in Unilever, and as emerging markets have recovered particularly in the last three or four months. So also has Unilever.Read Full Transcript
McDevitt: It seems like stock has bounced back.
Hartford: It has; it has recovered quite a lot from the relatively low positions that it was in maybe last October, last November. It never really got bargain-basement cheap enough for us. So the position remained relatively modest, but one of the challenges today is equity markets have appreciated a lot, and a byproduct of that is that the stocks that haven't appreciated or have been left behind have been left behind for a good reason. And I think it's inevitable that you are then going to be forced as a value manager to look at those companies that have been largely forgotten, and in so doing, if you buy a lot of them or you buy a greater number of them, you embed idiosyncratic risk into the portfolio because the companies have issues.
That's the reason why they have lagged the market or have failed to appreciate in line with the S&P 500, the DAX, or the FTSE, which are at or close to all-time highs. So those entities that haven't participated have done so for a reason, and we want to make sure that as investors when we are gaining exposure to them that there is support of an investment case.