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Market Q and A: Martin Cobb

Saturday 24 March 2007 11:35AM

What opportunities are you seeing in current market conditions?
 
In 2003, a lot of cyclical stocks were coming onto our global equity database because of Sars, the Iraq war and worries about economic slowdown. Roll on four years, and there is no obvious sector where we are finding particular value today. There has been a significant compression of values across sectors. In that sense, it is proving more difficult to identify here the next obvious stock is going to come from.
 
Of themes I would highlight today, one would be the megacap stocks. Whether you are covering pharmaceuticals, banks, telecoms, oil and gas, IT or media, some of the largest and most liquid stocks in the world appear to be offering good value at this time. A second theme is that some of the more sustainable growth entities, quality stocks, however you want to describe them, large companies with ungeared balance sheets have been overlooked and are coming back into the frame.
 
An increasing number of these quality stocks are meeting our valuation criteria. The list includes Microsoft, Oracle, Chevron and General Electric. In the UK, examples would include HSBC, BP and Vodafone, which we were buying this time last year. History tells us to buy stocks that are cheap. Just as in the 1990s, value will come through in the fullness of time.
 
In the UK private equity is very much focused on medium and small sized companies. They have been buying companies and we have benefited from that, with some of our midsized holdings being bid for, but in our view a lot of that is now in the price. That is obvious with the average stock in the FTSE 250 index on multiples of 17-18 times earnings, versus 12-13 times for stocks in the top half of the FTSE 100. That is not a topdown view. It is just that as analysts we are not coming up with many medium sized companies that are cheap.
 
Name three stocks you have been buying or finding attractive and why.
 
1. Carnival 
The cruise ship operator has a dual listing in the UK and the US. The company has one of the strongest business models I have ever come across in a company. There are huge barriers to entry. The industry is a duopoly, or at least an oligopoly. Long term supply demographics are favourable. We started buying in the summer last year, when the shares were knocked by worries about fuel costs, hurricanes and the US consumer, all of which proved to be overdone. We were buying the shares on their cheapest rating for 10 years. It is a classic Templeton stock, a great long term business trading on a low valuation for reasons that are temporary in nature.
 
2. Game Group
This is our largest holding. We have made good returns already but we still see the shares as attractive, having gone up 70% since we bought it. The argument is that it is are exposed to the console cycle, with a third of the UK software and console market. There is a very strong console and the margin poential from selling second hand games looks very attractive. The rating is more 20 times near term earnings, but with such strong growth in the top line and the margin, they are trading on a 10 x multiple on a five year view, not a level we would normally sell. We typcially buy stocks in sincgle figure five-year p/es and look to seel in the low teens. We see further upside, although we wouldn’t want to overstay our welcome.
 
3. Future Publishing
This is a magazine publisher that specialises in very concentrated niche titles rather than big consumer titles. Its problem has been that it doesn’t make enough money. EMAP and IPC typically make 15-20% operating margins, yet this business is making only a single digit margin. With a new management in place, we think it can make a 10% margin, even with all the moves towards online, and worries about that. On that basis, the stock still looks cheap. If the new management's strategy doesn't work out, somebody else may come along and finish the job. The rating, 10x near term earnings, gives the new management no benefit of the doubt of what the new management can achieve. On our five-year numbers, the shares are trading on 5-6 times forward earnings.
 
Which is your take as the analyst on the global energy sector?
 
We are underweight globally in energy stocks and have been for quite some time. We were selling significantly in 2005, although we have been buying more of late and along with other megacap sectors, are still looking to increase. In the UK, we will always be underweight in Big Oil as the companies are such a big part of the index. The global oil and gas stocks have significantly underperformed yet are producing amongst the highest free cash flow yields. Oil prices may decline, but unless you believe in collapse to an oil price back in the $30 a barrel range, the shares have strong reserves backing and cash flows. They look attractive on a $40-$45 oil price view. Being underweight has been the right place to be, but sitting here today it is an area where perhaps we should be increasing our weightings.
 
How do you interpret the recent market wobble?
 
Any sort of shakeout is always a great environment for the stockpicker, particularly one with a long term view. Last spring the shakeout created opportunities to pick up small and medium cap stocks. More recently, we think that concerns about sub-prime lending have been more than overdone at HSBC, for example. We are happy to be buying that stock, given that is has one of the strongest banking franchises and is trading on one of its cheapest ratings for many years. Irrationality will always persist. As long term value investors we have the luxury of betting against the crowd and a client base that understands what we do.
 
What research has impressed you recently?
 
The Little Book That Beats The Market [by Joel Greenblatt] has a very simple and interesting approach. There is a strong correlation between the simple method that he describes and the value investing we do here. You have to have the discipline to buy what others are selling. On the sell side, James Montier at Dresdner Kleinwort always has some very perceptive pieces on value investing.
 
Any comments on the market outlook in general?
 
We are stockpickers, but risk appetite still seems pretty high. The environment is benign. Typically that doesn't last. It waxes and wanes.  However, we don't have the skill set to time the market, so we look to be fully invested at all times. Cash is just a stock that doesn't go anywhere. Even if you go back to 1994 and 2002, which were two of the worst periods in recent market history, one third and one quarter of the stocks in the FTSE All-Share index went up on a 12 month view. All we need is for more than 30 stocks to go up from here; and our job is to find them. There is plenty of opportunity to buy cheap stocks if you have a five-year view as we do.

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