Jason Stipp: I'm Jason Stipp for Morningstar. With Europe having one of its worst weeks in about the last three months or so, we're checking in with David Herro. He's a manager at Oakmark International.
He was also named Morningstar's Fund Manager of the Decade recently. He's got a lot of holdings in Europe, but we want to get his take on what some of the action over there means for his portfolio holdings and his outlook. David, thanks so much for joining me.
David Herro: You're welcome. I'm very happy to be here.
Stipp: The first question for you: Your portfolio holds more that 50%, at least from the last reported portfolio we have, more than 50 percent in Europe. Obviously, Europe's sensing some shocks today. The Greek crisis seems to be spilling over. There's also some uncertainty in the UK.
We spoke with some others today, including Mohamed El-Erian, and he said that a lot of these instances in Europe may lead to deflation. I was wondering what your take is on an equity level for your European holdings. Might this affect the valuation of those holdings, and has the situation changed for those stocks?
Herro: I'll tell you what, it's mixed. I think for those companies which are outwardly focused, that perhaps are dollar earners, have a lot of exposure outside of Europe, this depreciation of their home currencies is actually going to be very beneficial to them, both in terms of competitiveness, and in terms of when you start reporting income.
All else being equal, it's going to be substantially higher as they are operating in currencies that have...their home currencies weakened, and they're earning profits in strong currencies and are bringing them back home.
So if you're an exporter or a global company, all else being equal, operationally, things are good for you. However, if you are a company that is dependent on European consumer spending alone, you're probably going to be in a little bit of trouble.
Stipp: Speaking on the consumer front, your portfolio does have some exposure to some quasi-luxury brands: Van Cleef & Arpels, Richemont, Cartier. Do you think that these companies may face some serious headwinds for their business in Europe?
Herro: European business, all else being equal, probably yes. Headwinds is a good way to describe it. Meaning certainly things are just finally starting to get better in Europe with the consumer.
Again, a lot of Europe stopped spending, not because the consumer itself was over-levered. Generally speaking, the European consumer has a high savings rate and a lot of money in the bank, but they were fearful and frightful.
We were just coming out of that. We were just starting to come out of that, and now we're right back in it again. So these types of consumers who buy these goods aren't ones that are necessarily going to be hit hard financially, but they're not going to spend out of fear and fright.
As I said, we were just getting over it, and now in the short term, we're going to feel that chill again. The good news is, though, this is probably less than a third of their revenues.
Over half their growth and a third of their revenue comes from the developing world. So far, that business has gone from strength to strength.
Stipp: David, do you think these issues, that they just lengthen your time horizon for these stocks? Or do you think that there may be a case to trim some of them because of the more intense headwinds that maybe were expected.
Herro: I would say almost the opposite. Although they're going to be impacted in the short term; in many cases the share price have been hit 5, 10, 15, 20 percent in the last couple week alone.
If you look at European markets, I believe they were down about four percent today. I think in the last two weeks Europe has to be down north of 10 percent.
Now, has what we've seen today caused the companies fundamental business value to drop that much, as much as the market is saying they've dropped? I think generally speaking the answer is no.
Stipp: OK. Based on that, have you been doing any bargain-hunting? Have you been looking out there to see if there are some opportunities because of this pullback? I know a lot of investors on Morningstar's website, they've been looking for something like this to deploy some capital.
Herro: Yes. And incidentally, I think there have been a lot of investors, money on the sidelines--European investors in particular, I would add--and the answer always was, "We're waiting for the second shoe to drop."
Well, I think the second shoe is dropping. I doubt if they'll buy in right away. They'll wait until the next spike up, because that's the way people are. They say they'll wait for the shoe to drop, but when it drops they're too scared to do anything about it.
What we've been doing is nibbling. It's one thing I have learned is you don't just rush in. You don't just pile all in at once since things look cheap. It takes a while for these things to get digested.
As such, what we like to do is gradually increase exposure to those companies we own which we think have been unfairly hit. That is, their share prices are down a lot more than the corresponding declining intrinsic value. If any, by the way. In many instances there hasn't been a decline in intrinsic value.
We've actually added a company. We've added stock in the banking sector of all places, in a Spanish bank. A good quality business we've been watching for a long time. It wasn't cheap enough. And in the last three or four or five weeks, Banco Santander--which is one of the most quality global financials that exists--they finally succumbed and the price got hit quite hard. So we've gently been adding it to the portfolio. We've added it to the portfolio and been gently buying it.
Stipp: David, speaking of financials, last question for you. With the problems with the sovereign debt, do you feel like there is a risk that with the financials that there may be some debt on their books because of this, that could potentially have a toxic effect, almost like we saw with sub-prime mortgages in 2008? Do you fear any sort of credit crisis in financials--and you hold some financials in Europe--because of the situation that's going on there?
Herro: Yeah. I think if the holdings are in Greek debt, there should be legitimate concern. I do not believe that a holder of Greek debt today will come out whole. It is possible. It is possible, but my personal view is that there's only about 30 or 40 percent chance that you'll make it out whole.
Why do I say that? Because the amount of debt, and the Greek ability to pay back that debt, and desire to pay back that debt, would cause me to question whether one would come out whole.
I believe if someone holds Portuguese debt, Spanish debt, Italian debt, Irish debt, German debt, there's nothing to worry about. I think Greece is actually the special situation. Greece should have never been put into the European monetary system.
If Greece was its own country, it's currency would have been heavily devalued. They don't have an export sector. Their biggest industry, perhaps, is tourism, followed by shipping.
This isn't a place that's going to busily pull themselves through it, as we're seeing the last couple of weeks. They're not Ireland. Ireland had this problem a year ago. People don't even realize that Ireland had this problem. Ireland made the adjustment.
Real wages in Ireland are down over 20 percent in the last 18 months. People have taken pension cuts; people are working two jobs. Ireland is now coming out of their recession. And you didn't see water cannons and street protests and tear gas; they just did it. And Greece is different.
Stipp: David Herro from Oakmark International. Thanks so much for spending the time with us today, we appreciate it.
Herro: Thank you.