FPA Capital Is Recycling Its Gains From Energy Names


Mutual Fund Quarterly

FPA Capital has hit a relative rough patch. Last year the storied, $1.2 billion portfolio topped 85% of its Morningstar category.

Now, with a 2% loss for the year going into Tuesday that lagged 99% of its category, the fund's 10-year average annual return of 8.56% tops "only" 76% of its peers.

But it would be rash to dismiss this thoroughbred fund based on a turbulent half year.

FPA Capital, now closed to new investors, has long said it is right only for shareholders who have a long-time horizon, not for those who get antsy about short-term volatility.

Co-manager Rikard Ekstrand, 47, and Steven Romick, 49, one of FPA's three managing partners as well as helmsman of $8.7 billion FPA Crescent , spoke with IBD separately from their offices in Los Angeles.

IBD: Has the second quarter been a buying opportunity for you, Rik?

Ekstrand: The first couple of months we kind of nibbled on a couple of names. We haven't disclosed names yet, so I can't say which ones.

Now (in the past week) and the week before, some names we like have come down more, so we've gotten more active. We have orders on the trading desk for several existing names and a few completely new ones.

So we've added to two E&P names. And we have trading orders for a couple of oil services names. And one tech name.

IBD: Any others?

Ekstrand: We have a new name on the health care side that we're getting close to adding to. It's within 3% or 4%, maybe 10%, of the price where we'll buy. And we have a defense related name that's closer, maybe within 5%.

IBD: In a recent commentary, you said the fund gained less than the broad market in the first quarter due to its large cash weighting. That was 32% as of March 31. Did you sell a lot of last year's big gainers?

Ekstrand: Yes, the cash position was built as a result of stocks that got to fair value or a premium.... Cash was 30.56% at the end of June.

We sold 135% of what we originally invested in E&P names. We sold 84% of our initial stake in oil services names.

Now we're turning around and putting some of that back in.

IBD: Energy wasn't the only sector you trimmed, was it?

Ekstrand: We also trimmed other areas, including retailers, tech and industrials. We trimmedAvnet ( AVT ) andArrow ( ARW ) in Q1 on the tech side. We trimmedFoot Locker ( FL ) andSignet ( SIG ), alsoTrinity Industries ( TRN ). We trimmedRowan (RDC) when it was higher. AlsoBaker Hughes (BHI).

I still like what we have in those names at their new weightings.

IBD: Western Digital (WDC) is down. But you're bullish on the stock. You see earnings and cash flow rising in part due to the firm's takeover of Hitachi's hard-disk-drive business?

Ekstrand: Its price-earnings ratio is around 5. Its price-to-cash flow is about 3. So we think it is undervalued. We also think the combination with Hitachi makes the company much stronger.

And the Hitachi move consolidates the industry.

Western Digital generates a lot of their components for disk drives. Toshiba, which is smaller, has to buy components from vendors and loses margin on that.

IBD: Veeco (VECO) is up this year, though quarterly sales and earnings per share are slowing. You more than doubled your stake in your latest disclosure. What do you like?

Ekstrand: People are very concerned about the slowdown in orders for the company. The stock went down from the mid- to high 50s to just above 20. When it got to the mid 20s we started to get pretty attracted and felt the negatives were priced into the stock.

We believe the earning power of this business is going to be in the $3 to $4 range in a normal year. That assumes it sells about 45% of the industry's 450 to 500 (MOCVD, or metal organic chemical vapor deposition machines, critical for manufacturing high-brightness, light-emitting diodes).

IBD: You opened a position inFederated Investors (FII) a few disclosures ago. You've said rising interest rates will help them. How so?

Ekstrand: They have fee waivers to a large extent when rates are so low. The full-year hit to fees from waivers using the Q1 2012 run rate is 55 to 60 cents per share.

IBD: You increased your stake inInterDigital (IDCC). What's your play?

Ekstrand: The company owns patents related to wireless technology. Two things can unlock value for this company. One is that they've got a lawsuit against several of their larger licensing clients, whom they say have not paid up for their 3G patents. So if they can make those people pay or find a way to structure (some settlement), that would unlock value.

Also, they recently entered into an agreement withIntel (INTC) for $375 million for selling certain patents, which are totally unrelated to IDCC's fee-generating patents and which would not impact its fee-generating capacity. Those were 8% of their overall patent portfolio. The $375 million was worth $6 a share when the stock was in the 24 range. So the patents were not well reflected in the stock. If they do more deals like that, that can unlock more value.

IBD: Trinity Industries ( TRN ) is down despite two quarters of triple-digit earnings per share growth. What's your thesis?

Ekstrand: When people get nervous about the economy, which they are now, this stock tends to come under pressure, which it has.

The company leases rail cars. It also makes them. It makes barges. And it has a construction business.

When we look at the company on a more normalized earning power, we think it can earn in the $3.50 range. So we think (its current price) is quite attractive. To realize its value, all we need is less fear and a moderate economy.

IBD: Steven, what is Crescent Fund's key characteristic?

Romick: We're a go-anywhere fund. We can buy across the capital structure, asset classes and market caps. We buy common stock and preferred, performing credit, distressed, bank debt and an odd smattering of smaller private equity. Nobody else has that kind of girth. We're good at buying businesses that have stumbled.

IBD: What are some examples?

Romick: Currently we have a decent chunk ofOmnicare (OCR). It's down, but up substantially from where we bought it.

IBD: Your thesis?

Romick: We first started buying in 2007. Then we sold. We didn't like the management team. We bought back in when the management team changed. And we like the new CEO, John Figueroa. We like what the new management has been saying, specifically a focus on better capital allocation. They're focused on technology and girth.

IBD: You've builtTesco (TESO) the past four disclosures. What do you like?

Romick: It was a U.K. business whose competitors caught up and the stock went down. Now it has a good management team. They're good at managing capital. And they have terrific market share in emerging markets, so they're not just a U.K. company.

IBD: Tell me why you've been building WPP, an advertising agency.

Romick: They've got double-digit returns on equity and double-digit margins. About 37% of their business is from Europe. That's a head wind. But as advertising is cut, they don't lose money. They just make less money. They get 30% of their revenue from emerging markets.

IBD: You have a lot of cash. Why?

Romick: We have about 25%. That's our historical average. Cash is an opportunity to put money to work in the future.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ, Inc.

This article appears in: Investing , Mutual Funds

Referenced Stocks: ARW , AVT , FL , SIG , TRN

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