Barron’s recently caught up by phone with the members of our January Roundtable. Here are the latest investment views and stock picks of Meryl Witmer, a general partner at Eagle Capital Partners in New York.
Meryl Witmer: It seems to me that equity valuations are all over the place. There are bubbles in some stocks that have recently come public, while more-industrial types of companies are wallowing at low valuations. Tell me what is happening with China, and I’ll tell you what the market will do. It is also possible that a Democratic president will be elected in 2020, but I see the current candidates as a negative for the market. We are searching for stocks that provide downside protection.
That sounds sensible in any market. What appeals to you lately?
I have three picks. The first is a large-cap and a new position for us:
[ticker: MS]. It has 1.7 billion shares outstanding and trades at $43 a share. Its book value at the end of the first quarter was just that, $43, and its tangible book was $38. Last year, the company reported earnings of $4.73 a share, which we adjusted down to $4.60 because of a one-time tax benefit. So, the stock is well-supported by book value and earnings.
2019 Mid-Year Roundtable
Morgan Stanley’s two main business segments are its investment banking and institutional trading operations, and wealth management. The investment bank produces about 55% of pre-tax income; wealth management, about 40%. The wealth management business is really underappreciated, given its sticky client base, recurring revenue, and long-term growth outlook. The government has lowered the capital requirements for Morgan Stanley. That frees up capital for share repurchases and dividends beyond our estimates.
At the investment bank, earnings can be volatile quarter to quarter, depending on the market for initial public offerings, merger-and-acquisition transactions, and fixed-income trading. However, pretax income in the segment over the past three years, through 2018, was $5.1 billion, $5.6 billion, and $6.26 billion, respectively. It is much steadier when looked at over the course of a year, rather than a quarter.
Are you a fan of management?
Yes. The CEO, James Gorman, took over in January 2010, and runs a tight operation. He really understands and controls risk. Just assuming continued share repurchases at current levels, Morgan Stanley earnings should grow to about $5.30 a share in 2020. Our pretax earnings assumption is $11.29 billion. For every billion under or over our assumption, Morgan Stanley’s earnings sensitivity is about 50 cents a share. Our price target on the stock is north of $60. It is a very good business, and the dividend yield is 2.8%. So, we see the stock producing a total return of 40%-plus over the next two years, with real book value to provide support on the downside. And if there is growth in the business or regulatory relief on the capital requirements, there will be more upside. The company also has a good loan business; it continues to grow and generate net interest income for them. Morgan Stanley is solid and well run.
To what degree does your forecast depend on the market’s continued advance?
If the markets go down, that will hurt some of the assets and Morgan Stanley’s fees on the wealth-management side. But if the markets grow at an average rate over time, their earnings should climb around 7% a year in the long run.
Our next idea,
trades in Switzerland under the symbol LHN. It is a global cement producer, and is vertically integrated into aggregate and ready-mix and other building materials. It is the product of the 2015 merger of Lafarge in France and Holcim in Switzerland. Asia, Europe, and North America each represent about a quarter of the group’s profitability, with the balance being in South America, the Middle East, and Africa.
The stock trades at 48 Swiss francs [$48.29]. The market cap is $30 billion. They are selling some assets, and their debt will be down to about $12 billion by year end after the sales. The merger was pretty difficult, given the different cultures, the levered balance sheet, and a bloated cost structure. They needed a change in leadership, and they brought in a talented CEO, Jan Jenisch, in late 2017. He had been chief executive of
[SIKA.Switzerland], a building-materials and automotive-product company, where he had a great track record. Sika’s stock compounded at a 28% annual rate while he was CEO. He fosters an entrepreneurial culture, allocates capital wisely, and makes high returns on acquisitions. At Lafarge, he’s taking $400 million out of the cost structure by closing redundant headquarters, eliminating layers of management, and pushing responsibility down to the plant level. He also did something interesting: They have a once-a-year dividend. He allowed shareholders to receive discounted shares if they so wished, instead of cash.
That sounds unusual.
It is, but it is a great idea because it is fair to everyone and it gets your balance sheet where it should be more quickly. That has helped him pay down about $900 million in debt. LafargeHolcim is about the industry’s only company with a solid, investable balance sheet. Almost every other company is very leveraged. Operationally, they’re well-positioned. North American fundamentals are healthy; cement prices are above $100 a ton. We think there’s pent-up demand for housing and infrastructure work. In Europe, cement prices are around $85 a ton, but it varies widely by country. In Asia, Lafarge’s main exposure is through two public companies, in China and India.
What are your earnings estimates?
Lafarge can earn $3.42 a share in 2019, with $4.76 a share of free cash flow. Our model assumes moderate growth of 4% going forward, in line with the company’s target of 3% to 5%. By 2021, Lafarge could be generating about $5.65 in free cash flow. We think the stock is worth 12 to 13 times earnings, or CHF68 to CHF73 a share.
What is your third recommendation?
[FOX, FOXA], which was spun out of 21st Century Fox at the time of
’s acquisition of 21st Century Fox assets. Fox trades around $36, and it operates cable TV stations, notably Fox News and Fox Business News, and the Fox station and network. It also has Fox Sports, FS1, FS2, and the Big Ten Network.
We should note that Rupert Murdoch, chairman of Fox, is also executive chairman of
[NWS], which owns Barron’s.
Fox CEO Lachlan Murdoch [Rupert Murdoch’s son] has said that Fox’s operating structure is relatively simple. Half of the company’s revenue comes from contracted, growing affiliate relationships; half is from advertising. Of the advertising revenue, 70% comes from live news and sports. In my view, that makes Fox’s programming much less vulnerable to competition. Regardless of whether your readers like it or not, Fox News is a phenomenon. It has terrific ratings. It is a must-see for half of the country. Maria Bartiromo at Fox Business has a great ability to get exclusive interviews. Greg Gutfeld at Fox News has a sort of comedy show on Saturday night that I think rivals Saturday Night Live.
So you watch him on Saturday nights?
No, but I do tape his show. Even if you are a [cable TV] cord-cutter, you still get Fox benefits in [streaming] packages, and Fox still gets revenue and earnings. Revenue and earnings will be driven by increasing affiliate fees, although the drop-down to earnings from these increases is obscured in fiscal 2020 [ending in June] from increased investments into TV production growth and Fox Nation, and the cost of bringing World Wrestling Entertainment to Fox. Later, you will see earnings growth. Fox’s Ebitda [earnings before interest, taxes, depreciation, and amortization] in the fiscal year ended 2019 should be about $2.5 billion to $2.6 billion. We see that growing to $2.8 billion to $3 billion by fiscal 2022.
Fox will generate several billion dollars of free cash between now and 2022, and they own 7% of
[ROKU], plus a valuable studio lot in Los Angeles, currently leased to Disney. These and other assets and cash add about $6 to $9 a share in value. As a result of the spinoff, Fox also has a tax shield, so it will pay minimal taxes—say, $300 million annually—for 15 years. We think the stock’s valuation is good. Rupert Murdoch bought about $20 million worth in the open market recently at around $35 a share. We think the stock can hit $45 to $50 within a couple of years, and Fox’s strong cash flow gives it downside protection.