Every value investor envies legendary money manager Mario
Gabelli's genius -- and for good reason.
Gabelli leads GAMCO Investors, a $36 billion global investment
firm known for bringing its clients 16.3% annualized returns
since its founding in 1977. He was named the 2010 Institutional
Investor "Money Manager of the Year" and has a net worth of more
than $1 billion, according to Forbes.
Gabelli uses a bottom-up, value-driven approach to identify
bargain-priced stocks, then looks for catalysts that may unlock
the company's hidden value. He looks for industry trends,
regulatory changes, merger opportunities and spin-offs, for
Gabelli shared his top stock picks for 2013 in February at a
Barron's Roundtable. Most of his favorites are thought to be ripe
for a merger or spin-off this year. Here is a closer look at five
of Gabelli's top picks.
1. Post Holdings (
This leading cereal maker was spun off from Ralcorp Holdings in
2012. Post has a 10.5% share of the $10 billion U.S. cereal
market and owns brands such as Grape Nuts, Raisin Bran and
Gabelli likes the stability of the cereal business and thinks
Post is a strong cash flow generator with good pricing power. He
also considers Post CEO Bill Stiritz a savvy deal-maker --
Stiritz negotiated the sale of Ralston Purina to Nestle in
Improved volume and higher selling prices resulted in 8%
growth in Post's sales to $237 million for the first quarter of
2013 compared to the same quarter last year. Meanwhile, cash flow
climbed 15% to $52.5 million. Earnings per share (EPS) fell 16%
to 31 cents due to costs surrounding the separation from Ralcorp,
but Gabelli thinks the company will earn about $1.50 this year,
which could grow to $3 in the next three to four years.
Post shares are priced at only 1.1 times book value. This is a
steep discount to competitors
General Mills (
, whose shares trade at price-to-book value multiples of 9.5
times and 4.4 times, respectively.
2. Patterson Companies (Nasdaq: PDCO)
Patterson supplies dental products and imaging equipment to some
185,000 U.S. dentists. The dental market benefits from an aging
U.S. population that will require more dental care.
In addition, Patterson owns a veterinary products business
that serves a $3 billion market. Patterson trades at a 10% lower
price-to-earnings (P/E) ratio than its main dental products
Henry Schein (Nasdaq: HSIC)
and a 30% lower P/E than its principal veterinary products
MWI Veterinary Supply (Nasdaq: MWIV)
, making it attractive in both industries. For these reasons,
Gabelli sees Patterson as a likely candidate for a takeover or
Patterson increased sales 3% during the first nine months of
fiscal 2013 to $2.67 billion from one year earlier; EPS improved
5% to $1.41. Analysts predict 6% earnings growth this year, and
rising another 10% next year.
The company generates more than $300 million in cash flow
annually, but uses only $30 million for capital spending, leaving
plenty of cash to return to investors. Earlier this month,
Patterson authorized a 25-million-share repurchase and hiked its
dividend 14% to a 64 cents annual rate yielding 1.7%.
3. Smithfield Foods (
Smithfield is the world's largest pork processor and hog producer
and owns the Eckrich, Farmland and Armour brands. Breakfast
sausage is a $4.6 billion U.S. market, growing about 5% a
Smithfield's sales were flat at $9.9 billion during the first
nine months of fiscal 2013; EPS fell 40% to $1.03 due to losses
in the hog production business.
Investors are pushing for a breakup of the company. According
to Goldman Sachs, separating Smithfield's pork processing, hog
production and international operations could yield a breakup
value as high as $48 a share, or nearly twice the current share
price. Continental Grain has issued an offer that Smithfield's
board is reviewing.
4. Hillshire Brands (
Another takeover candidate identified by Gabelli is
Hillshire Brands (
, which was spun off from Sara Lee in 2012. Hillshire is a market
leader in the breakfast sausage, lunch meat and hot dog
categories. Several companies were bidding to acquire Hillshire
from Sara Lee before the spin-off.
Hillshire's EPS rose an impressive 49% during the first half
of fiscal 2013 to $1.10 on a 2% rise in sales to $2 billion.
Management has updated full-year EPS guidance to a range of $1.60
to $1.70, up from $1.40 to $1.55. Hillshire is priced at a P/E of
6, while competitors
Kraft Foods (Nasdaq: KRFT)
are each priced at a P/E of about 20, making Hillshire that much
more interesting. Hillshire also pays a 50-cent annual dividend
and yields 1.5%.
4. Graco, Inc. (GGG)
Graco manufactures industrial pumps, mixers and meters. The
housing recovery has helped this company, which produces mixers
and applicators for painters. Graco also benefits from the oil
and gas industry -- its pumps and injectors are used on drilling
rigs. Although Graco's sales rose 13% to $1 billion in 2012 from
the previous year, EPS improved by just 4% to $2.42: Expenses
were incurred due to its 2012 acquisition of businesses from
Illinois Tool Works (ITW)
. Gabelli thinks Graco's earnings will double within four years
as the housing market improves and costs from the Illinois Tool
Works acquisition are gradually absorbed. Graco also pays a $1
annual dividend yielding 1.7% and has been growing its dividend
by roughly 5% a year.
Risks to consider:
Rising grain prices could hurt Post's profit margins and
increase feeding costs for Smithfield's hog production
operations. Smithfield could also be affected if budget cuts
force the U.S. Department of Agriculture to furlough some meat
inspectors later this year.
Action to take -->
I think Graco is the best of these five picks because of its
business model and benefits from the housing market recovery. I
also like Patterson for its growing markets, rich cash flow and
dividend growth. Post, Smithfield and Hillshire are
bargain-priced but dependent on a catalyst event such as a
takeover offer to unlock value.