Fewer Values in Europe Than Expected

Ryan Leggio: Hi. I'm Ryan Leggio. I'm a mutual fund analyst at Morningstar. With the concerns in Europe roiling the market and with the MSCI EAFE down about 10% over the last month, we wanted to have Kimball Brooker, a portfolio management at the First Eagle Funds, in with us to discuss the challenges and opportunities going on in Europe.

Kimball, thanks so much for joining us today.

Kimball Brooker: Thanks for having me, Ryan.

Leggio: So, as of the end of July, the portfolio had around 16% in Europe. How are you dealing with the market conditions over there right now?

Brooker: We do have the global fund. It does have about 16% of the portfolio in Europe. The bulk of our European exposure is in France, Germany, and Switzerland. At First Eagle, we have a bottom-up approach for investing. We look at every security on its own merits as we've done historically and seek to find businesses that occupy dominant positions within their part of the economic infrastructure or ecosystem. And we acquire them at significant discounts to what we think they are worth. For us, nothing has really changed in our approach to investing in light of what's been happening during the last few weeks.

Leggio: So the concerns about slower growth and the sovereign debt worries really haven't brought down to any measurable degree the intrinsic value estimates that you have for most of your companies in Europe?

Brooker: No, not for our larger positions. Our larger positions tend to be global franchises that might be domiciled in Europe, but that operate all over the world. And so a business like Sodexo, for example, which is a significant player in the global catering industry, it is resilient enough we think to survive these ups and downs.

Leggio: On the topic of global franchises, late in July, one of your co-portfolio managers mentioned on your conference call with investors that many of the global franchises domiciled in Europe were "frustratingly, efficiently priced" and a lot of them were trading near intrinsic value. With the market turmoil during the last couple of weeks, are you starting to see some of those trade at better valuations or is there still not enough margin of safety for some of those names?

Brooker: There have been a few. We have been very selective and very deliberate. I think that our view couple of months ago was that the franchise types of businesses were frustratingly, efficiently priced and the European banks looked statistically cheap but were probably not an area that we were going to spend a lot of time focusing on.

In the interim, the markets in Europe have really been led down by the banks, and frustratingly, efficiently priced franchise businesses have generally become a little bit cheaper but for the most part have not really traded into a range where we feel comfortable that we're obtaining an adequate margin of safety.

So, it's a bit of a mixed picture, we're starting to see some value in some of the companies that we are interested in, but given what's happened with the overall markets, I would say, we're finding fewer opportunities than you would expect. There still are some, but it's not as many as you would think.

Leggio: To your point about European financials, many of them are trading at significant discounts to their reported book values. Is really there any price that would get you interested in some of these names with so much controversy?

Brooker: Well, the key word in your question was reported book values. I would say that, in terms of financials and banks in particular, for any bank, there are some hurdles that we have to get over that are difficult for us. The first is the structural leverage in a bank's balance sheet, and a bank with $100 of assets may have $5 or $10 of equity capital supporting those assets. So, the leverage inherent in a balance sheet like that means that you have very little tolerance for error on that $100 of assets, where a very small movement can create a very negative effect on the equity.

The second issue is the opacity of many of these balance sheets, and whether it's accounting or contingent exposures, it's just quite difficult for us to get comfortable with a large bank, and many of the European banks are very large and very complicated. So, I think that it would take quite a bit for us to get comfortable: A, that we fully had our arms around the exposures that we were dealing with, and B, that we felt that we had some transparency around what the assets were worth. So, never say never, but I wouldn't expect us to be trawling those waters anytime soon.

Leggio: Well, Kimball thanks so much for providing us an update of where you guys are finding values in Europe.

Brooker: Thank you very much for having me today.

Leggio: Thank you for joining us. For Morningstar, I'm Ryan Leggio.