It's been a cruel, cruel summer for equities. Uncertainty
continues to roil the markets, as choppy data neither confirm a
robust economic recovery nor rule out the possibility of future
weakness. Financial and health care reform, as well as the ongoing
disaster in theGulf of Mexico, likewise rattled investors' frayed
nerves. Markets may loathe uncertainty, but Tyler Dann II,
portfolio manager at
(CHTRX), welcomes this instability, noting that such
dislocations create opportunities for patient investors who do
What's your outlook for the market?
I wouldn't be surprised to find the broader market in the same
place a year from now, though a 20 percent upswing and a 20 percent
downswing could occur over that period.
It's tough for investors to find their bearings in this
grinding, range-bound market. Revenue growth drives the animal
spirits and gooses people up about buying stocks, but companies
continue to disappoint on this score.
Margins have increased, and profit levels have exceeded
expectations, albeit lowered ones. However, profit multiples remain
low because revenue growth isn't driving earnings.
Broad revenue growth requires a favorable economic backdrop and
companies that are committed to investing in their businesses
despite the short-term hit to earnings.
In a choppy and uncertain macroeconomic environment, only the
bravest corporate managers are willing to make the investments
needed to grow revenue; the market punishes names that fail to
forecast higher earnings.
Companies appear to be eating their seed corn, boosting profits
by cutting costs. The cost of goods sold as a percentage of sales
is at multiyear lows; productivity is at multiyear highs; and
capital spending as a percentage of sales is at multiyear lows.
It sounds as though you expect a recovery that's tepid at
That's fair to say. Right now corporations are playing turtle
because of concerns about regulations and taxes. Still, if
companies grow confident in the availability of credit and increase
capital spending, a positive feedback loop emerges that's conducive
Do you see more regulation on the horizon?
Energy, carbon dioxide emissions--you name it. Regulators across
the board have morphed into activist agencies rather than passive
Evolving regulation creates opportunities as well as challenges.
Health care reform, for example, has created quite a few
opportunities on the valuation side.
New regulation will constrain growth rates at some health care
companies, but in many cases the market's reaction exaggerates
Along the same lines, we've also added defense stocks because
conventional wisdom calls for a decline in military spending,
particularly on supplemental items. This broad-brush approach to
the sector obscures defense companies that are positioned for
robust revenue growth.
Are there any sectors you recommend avoiding?
For better or worse, we don't have a great deal of exposure to
large banks because, as much research as we do, we just can't get
comfortable with the composition of earnings and balance sheets. We
recognize that it's an extremely favorable environment for banks
right now as far as traditional spread-lending is concerned--that's
why we own
But we continue to worry about the things that people all too
willingly sweep under the rug--namely legacy investments that could
still cause pain. And although a lot of people say the new
regulations will be relatively toothless, the costs of these new
rules are difficult to foresee.
What are some of your favorite names right now?
), which has two operating segments: pharmacy benefit management
(PBM) and retail pharmacy. Despite stiff competition, the company
continues to perform well in both business lines. However, the
market struggles to value the combined operation; in our minds, the
sum of the parts suggests a valuation of at least $40 a share.
Some of the controversy surrounding CVS Caremark, from the fall
2009 pullback to the recent spat with Walgreen (
), stemmed from the business model that management is implementing.
The Maintenance Choice program integrates the PBM business with the
retail pharmacy, offering customers the choice of filling
prescriptions via mail order or at a retail location.
Investors questioned whether this move would attract new
customers or ultimately detract from business. The early read on
the most recent renewal season suggests that not only has business
stabilized, but the company is also winning share from the
) recent decision to outsource its PBM business to CVS Caremark is
another endorsement of this strategy.
Higher levels of insured customers should boost volumes, while a
wave of patent expirations on branded drugs in 2011 and 2012 also
bodes well for business; generally speaking, sales of generic drugs
offer significantly higher margins than branded products.
) is another baby that was thrown out with the bathwater, another
instance where controversy clouds investors' minds.
Over time management has demonstrated itself to be a good
steward of shareholder capital, buying mature fields from big oil
companies and squeezing production--and profits--from these
deposits. This strategy has enabled Apache to post good internal
rates of return and grow output at a high rate.
The turmoil that roiled shares of oil producers as crude flowed
from BP's (BP) blown-out Macondo well into theGulf of Mexico
enabled us to pick up the stock on the cheap.
Better yet, the disaster allowed Apache to reload its portfolio
at attractive terms, buying critical assets from BP--an opportunity
that wouldn't have emerged if BP didn't have to raise money to put
into the escrowed clean-up fund.
Apache also acquired Mariner Energy (NYSE: ME) back in April, a
deal that increased its offshore exposure in the Gulf of Mexico--a
prospect that became less desirable after the Obama administration
banned deepwater drilling in the region. This pushed the stock into
We believe that investors' undue focus on the controversial
moratorium (a short-term headwind), coupled with a long-term
opportunity to acquire mature assets at cheap valuations, create an
ideal opportunity to increase our position.
(KR) is a prime example of a company that has continued to invest
in its business throughout the downturn--an admirable commitment
that has gone unrewarded in the stock market.
Operating in a highly competitive environment, Kroger continues
to win market share through pricing initiatives, a compelling
strategy in a weak economy. Investors have complained that
inflation hasn't been embedded into food prices.
We take a different tack. Kroger may be winning market share
through lower prices, but the company will benefit
disproportionately when the industry recovers.
And management has a history of using free cash flow in a
shareholder friendly manner, buying back shares and growing the
What's your best piece of advice for individual
Don't get caught up in the hysteria, but be sure to have
definite reasons for sticking with your stocks.
Choppy markets require discipline and patience; you can't let
your emotions take over.
As Warren Buffett says, you have to be greedy when others are
fearful and fearful when others are greedy. We try to follow that
mantra every day; I would advise investors to follow a similar
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