INVESTMENT PHILOSOPHY

The first rule of fishing is fish where the fish are (Charlie Munger)

Our main objective is to acquire assets and cash flows at a price below their intrinsic value as a business.

21 . 04 . 2021
JOSÉ Belascoaín
Investor Relations

5 minutes

A fishing ground refers to a sea area where fishermen tend to cast their nets because of favourable conditions that allow for abundant fishing, i.e. where there’s a large quantity of fish. It’s therefore of the utmost importance for fishermen to guarantee their presence in international waters and to secure fishing rights in new fishing grounds.

“Favourable conditions”, in these two words lies the importance of the definition and in these two words lies the reason for the simile. Although at first glance it may seem somewhat confusing, it’s rather suitable for explaining our task of finding good assets at attractive prices.

At Cobas, as a main premise, we seek opportunities to assets and cash flows at a price below their intrinsic value as a business. This is because we believe that the market isn’t efficient all the time and, therefore, offers us this type of opportunity.

Based on this main idea, we can talk about market niches where we think that, in principle, cheap businesses may be present for various reasons that I’ll explain below. I will describe some of these “fishing grounds” below.

A. Cyclical investments

As a general definition, this involves companies which, for one reason or another, are exposed to fluctuations in the economic cycle.

A good example is car manufacturers, as their business depends on the purchasing power of the population, which fluctuates over time.

In other cases, the cycle may be due to an intrinsic characteristic of the industry itself. One example is the tanker sector, where the cycle is strongly influenced by the supply side. It isn’t very flexible when it comes to adapting to market conditions as it takes around 3 years to build a tanker.

Patience is essential for dealing with cycles, along with the belief that drops in share prices are due to the cycle. Cycles always turn around. This means opportunities here are simple to analyse as we already know what’s driving the movements.

Two key factors: the company needs to be an efficient producer with the capacity to withstand prices and it shouldn’t be holding much debt. Failure to meet these two conditions can put our investment at risk, as the company may not make it out to the other side of the cycle.

The main mistake with the cycle is trying to predict timing. Instead we should focus our efforts on enduring falls, as we’ll generally enter before the lowest point. The key is to continue buying throughout the fall, with patience and conviction.

As an example of cyclical investments, our portfolios include car companies and oil and gas shipping companies, which have always been part of our investments since the creation of our funds. Some of the most significant names are International Seaways, an oil tanker operator, or Renault, one of Europe’s leading car manufacturers.

B. Hidden value or holdings

This involves companies that invest in unrelated businesses, which can sometimes lack coherence, and can deter investors. Very few of them trade at their intrinsic value and therefore don’t reflect the sum of their investments.

Conglomerates or holding companies in general have extraordinary businesses hidden among not so good ones. Investing in the parent company is often a way to access them at attractive discounts.

This diversity, which is often present in the nature of the different businesses, is one of the main reasons why these types of conglomerates are often a source of assets that are incorrectly valued by the market. This is explained by the fact that analysing a holding company poses more difficulties and a greater workload than that of a normal company. This is because as analysts, we’ll have to study, analyse and understand several different businesses, with very different structures, dynamics and sectorial frameworks.

At Cobas, we can find examples of investments in these types of companies with very significant weightings, such as CIR in the International portfolio or Semapa in our Iberian portfolio.

C. Poorly followed or not covered by the investment community

The stock market is incredibly large and diverse, which requires us to be aware that we often may find companies that are fantastic businesses, but which aren’t the focus of the investment community.

The first source of this lack of market attention lies in the size or capitalisation of the company itself. The market generally pays more attention to large companies than to small companies, a situation that is largely driven by the low incentive of sell-side research firms to cover small-cap companies, due to the low demand from investors for information on very small companies, in part because of the low liquidity they tend to have.

Another “drawback” of small-cap companies is the fact that they are not directly accessible for large investors. Imagine a fund with assets under management of say €3 billion. Just by dedicating 1% of its assets to one company, it would already represent an investment of €30 million. In a company such as Vocento, with a market capitalisation of around €130 million, such a 1% investment would mean 23% of the company’s capital, which is perhaps too high an exposure within the same business.

Continuing with the analysis of possible reasons as to why the market may not pay attention to certain types of businesses, we may find companies that are listed on a certain market but nevertheless carry out their activity in a different market. This is the case with Atalaya Mining that is listed on the London Stock Exchange, although its assets are mainly located in Huelva, in the Rio Tinto mines.

D. Very likely to grow

There are companies which, either because of the type of business they operate or because of the company’s own characteristics that give them a competitive advantage over their competitors, are in a situation where there is a strong likelihood of future growth.

For example, one of the companies discussed above, CIR. KOS, its nursing home business, has a very likely long-term growth outlook, as demographics work in its favour. The ageing of the population is a given, and the public sector doesn’t have the capacity to meet all the demand, which means there’s a gap in the market for the private sector. Moreover, KOS has experience and a standing in the Italian market that isn’t easy to replicate, as it isn’t easy to build up a reputation overnight that takes years to develop.

In addition to all this, KOS operates and is listed in Italy, which isn’t a very large market on a global scale compared to the major markets such as New York or London, which attract the attention of a large part of the investment community.

E. Long-term projects

Investors lack patience and the stock market isn’t always the best place for such projects, leading to incorrect price formation and a possible investment opportunity.

These are businesses that win interesting contracts and projects, but that the market doesn’t value correctly due to a lack of the necessary long-term vision. They tend to be companies that don’t pay out large dividends in their early stages, as the financing needs of the projects prevent them from returning capital to shareholders, and in many cases have management teams that aren’t very active and communicative with regard to the market.

An example in our portfolios is the investment in Teekay LNG, a major liquefied natural gas transportation company globally.

When we took our position in the company, the market had heavily penalised the stock due to the cancellation of the dividend. The reason for the cancellation, however, seemed reasonable to us; they were going to start a fleet renewal plan that required a large initial outlay, which couldn’t be fully financed by debt.

In this case, the market, again in keeping with its short-termism, overlooked a company that wasn’t going to offer immediate returns, but with a growth plan at the lowest part of the cycle in its sector, which seemed entirely reasonable and made us think (and still does today) that it would be worth the wait.

F. Markets that are out of favour or seen as uncertain

Lastly, I’d like to mention another of the niches where it’s possible to find good businesses at attractive prices, due to characteristics or situations unrelated to the nature of the business itself.

Brexit is a very recent high-profile example. The process of the United Kingdom’s exit from the European Union is seen as a source of uncertainty by investors, who end up giving a lower rating to many of the companies listed on this market. This is due to the uncertainty they perceive to be associated with a political process that certainly has or should have little to do with the development of business in many of the companies available for investment. This is because given the nature of the business, such a situation shouldn’t pose any major problem for certain companies.

In the UK, we have positions in defence, consumer, commodity and car companies, with a combined exposure of just over 10% within Cobas Selección, our leading fund.

In any case, we don’t believe that Brexit will bring about a change in the habits or needs of their target customer. We believe that Britons will continue to buy electronic products, and therefore sales of Dixons Carphone, the market leader in the UK, shouldn’t suffer too much in the long term. They’ll continue to spend part of their national budget on defence spending, where our position in Babcock, a major supplier to the British army, comes in. We expect that Britons will continue to go to the pub for a pint and we once had an investment in Greene King, an owner and operator of pubs across the region, which we ended up selling after it received a takeover bid that was well in line with our target price. We also expect that oil producers, such as Cairn Energy, will continue to operate despite the UK leaving the EU etc.

In short, when you invest with the objective of acquiring businesses at a price below their intrinsic value as a company, you have to start by thinking about which parts of the stock market, so large and diverse, offer circumstances that might make you think you can find businesses there that meet our requirements for investing the capital of our investors in business projects. That is, after all, what we’re in the business of doing.

Ultimately, it’s a matter of identifying market segments where there may be a shortage of capital and analysing the reasons why. Getting there first will give us a big advantage in our search for profitability, while at the same time it’ll require a great deal of patience, nothing more and nothing less. The same patience that company managers apply when gauging the outcome of a project.

Returning to the initial simile, if we want fish, we need to find a fishing ground where we can cast our nets.