The Stock Picker's Ball

By JONATHAN R. LAING | MORE ARTICLES BY AUTHOR

As 10 investment heavyweights gathered in Chicago, the mood was anything by downbeat.

 

The atmosphere was less than salubrious for the Invest for Kids conference in Chicago, which is modeled on the Ira Sohn Research Conference in New York and brings together some of the top U.S. money managers to proffer their best investment ideas, with conference proceeds going to charity.

The weather last Wednesday was dank and rainy. That day, the stock market was getting drilled on news that Italian sovereign debt yields had surged through the 7% level, the supposed point of no return. Was much of Europe on an irrevocable path to a financial Jonestown?, bears wondered.

Finally, in financial circles in Chicago, long the citadel of futures trading, there has been plenty of gnashing of teeth over the apparent disappearance of some $600 million of futures-account customer funds in the bankruptcy of the trading house MF Global. Jon Corzine, MF's chief until recently, was a well-known liberal Democratic politician. But the idea of filching $600 million to help finance trades in the sovereign debt of Italy and other weak Euro-zone members seemed a bit much in wealth and income redistribution.

Despite all that, the conference was anything but downbeat, a tone that perhaps was vindicated by the strong rebound in prices in the last two days of trading for the week. And there was plenty of star power present, with former Junk Bond King Michael Milken and real-estate magnate Sam Zell book-ending the other eight speakers.

Milken offered no specific investment ideas, having devoted most of his time and benefactions to medical research, education reform and a think tank called the Milken Institute since leaving federal prison after serving 22 months for pleading guilty to federal securities-fraud charges. Among his observations: Rising obesity in the United States since just the '90s has resulted in an extra one trillion dollars in medical spending annually for something that's totally preventable, and Americans spend too much on housing and transportation (cars) compared with education, the reverse of priorities in Asian societies like China.

On the investment side, his insights were fairly standard. The European Monetary Union was in trouble because wide disparities in labor productivity between northern-tier states like Germany and Norway and the less efficient Mediterranean states lead to wildly different unemployment rates. Sovereign debt is not a sound investment vehicle anyway because there are so many recidivist defaulters historically like Greece. Growing populations and burgeoning middle classes make countries such as China, Malaysia, Thailand, the Philippines and India obvious places to invest.

Zell was asked to restrict his comments to the emerging world, a sector to which he has allocated some $2 billion in his investment partnership Equity International over the past decade or so. Most developed nations are afflicted by population decline. He singled out Japan, where by 2050 there will be only one working-age person to support each retiree.

He concentrated his remarks on Brazil, a particular focus of Equity International's investments. There the population is growing. The nation is self-sufficient in food, energy and water. Its middle class is surging from a current level of 25% of the population to 65%. Even socialist politicians like former president Lula have become free-market oriented and fiscally responsible. Go outside any major city in Brazil and the humming construction activity in housing and infrastructure reminds him of the U.S. in the '50s.

Barry Sternlicht of the Starwood Capital Group and founder of the Starwood Hotel chain sees harbingers of a turnaround in residential real estate over the next couple of years. There's lot of pent-up housing demand from continuing family formations, folks doubling up in houses and apartments or living with parents, low interest rates and improving affordability (the cost of renting recently reached the cost of homeownership for the first time in decades). Housing starts have dropped to between 300,000 and 400,000 when normal demand would call for 1.3 million housing starts. Foreclosures and mortgage delinquencies are starting to fall. Most important, sellers in locales not beset with lenders dumping foreclosed properties are seeing actual price increases.

He likes the homebuilder Toll Brothers (ticker: TOL) because of its strong cash position, decent land inventory and its market niche among more affluent buyers (homes of $600,000 and up). The affluent have suffered much less during the Great Recession and have the means to buy.

He also recommends Lowe's (LOW), the home-improvement and supply retailer, which could prosper when home construction takes off. Meantime, the company has coped by living off its apartment-repair customers. Lowe's has also engaged in a ferocious stock-buyback program that Sternlicht thinks could eventually suck up 70% of its outstanding shares. And Lowe's also affords a real estate play by virtue of owning some 90% of its stores.

For Rich Perry of hedge fund Perry Partners, who favors distressed investments, there's money to be made in the junior preferred stock of Fannie Mae (FNMA) and Freddie Mac (FMCC). This paper got torched in the government takeover of Freddie and Fannie in September 2008, leaving many community banks with huge holes in their capital. Their prices have since sunk to around eight cents on the dollar on securities with a par value of $36 billion.

As a contrarian, Perry thinks these preferred shares could eventually get back to par, for a potential payoff over 12 times current value. Though plans abound to wind down Fannie or Freddie, which have proved black holes for the U.S. taxpayer, Perry thinks the agencies are too integral to the U.S. housing market to be simply snuffed.

For one thing, the two companies could be revived by simply raising the guarantee fees they charge on purchased mortgages by a third or so from current 20 to 23 basis points of outstanding principal. In any eventual privatization of the two companies, Perry thinks that the junior preferred would become equity. The asymmetry of the potential pay-off to risk makes the preferreds compelling.

Value investor Thomas Russo, a partner of equity manager Gardner Russo & Gardner, recommends investing in the big European multi-nationals Nestlé (NSRGY), liquor giant Pernod-Ricard (RI.France) and beer company SABMiller (SAB.UK), despite or, perhaps, because of the blood running in the streets in European securities markets. A substantial portion of the companies' revenues come from outside the Continent. Thus any fall in the euro would lead to translation gains for the companies.

He also admires the companies for their worldwide reach, adeptness and tenacity in pushing into the emerging markets and powerful brand equities.

Hedge-fund manager Leon Cooperman of Omega Advisors raced through his presentation to get the conference back on schedule. He sees no double dip in the U.S. He has faith that the European financial crisis will eventually recede once politicians become frightened enough to force the European Central Bank to live up to its name and snuff out the contagion fears by committing enough euros to the effort. U.S. stocks seem to him to be cheap on a number of value criteria. Stocks are the "best house in the financial neighborhood, though there are doubts as to whether it's a good neighborhood," he quipped.

Among the names he threw out was Charming Shoppes (CHRS) with its big-size crown jewel, Lane Bryant. It's partly an obesity play, according to the somewhat corpulent Cooperman. He sees the company sharpening up its operations by among other things exiting the under-performing Fashion Bug business and eventually selling out or going private at a higher price.

Marc Lasry of Avenue Capital Group sees much value in the shares of General Motors (GM). He pointed out that the company's ratio of enterprise value to earnings before interest, taxes and depreciation and amortization stands at just one. Ford sells at an EV/EBITDA of three times. And GM has post-bankruptcy debt of just $5 billion.

The company's share price has been hurt by the U.S. Government's one-third ownership, the stigma of its bankruptcy and a management team unfamiliar to many investors. These impediments are more subjective than real. There's no reason at all why the stock won't triple or quadruple in price to reach valuation levels similar to other carmakers like Ford and Toyota.

Rounding out the panel, activist investor Barry Rosenstein of JANA Partners, who's part of a group pushing McGraw Hill (MHP) to restructure, insists that additional measures beyond what the company recently announced could drive the stock price up at least 40%. He feels that the cost-cutting goals and stock-buyback program disclosed are insufficient and the company would impart more value by being broken up into four units―text books, information and media, stock indexes and Standard and Poor's ratings, rather than just two units.

And finally Michael Elrad of GEM Realty in Chicago, is a fan of the Class A shopping-mall real estate investment trusts, arguing that the quality of their tenancy is better than ever and their rents are stable and rising leading to net operating income growth. Nor does the Internet threaten their future. Smart companies like Apple realized long ago that fancy showrooms in top malls are necessary to drive on-line sales. His favorite is the mall REIT Macerich (MAC). The company sells at a 10% discount to larger competitors like Simon Property Group (SPG), which in turn changes hands at a 20% discount to recent private-market sales transactions.

So overall, the message was clear: Ignore Europe and buy stocks.