Scottish Plays - Clunie's comments:
James Clunie of Aberdeen Asset Managers offers his views on
the U.S. and elsewhere
An Interview With James Clunie -- Not a day goes by, it seems, without yet
another chief executive of an American company handcuffed and carted away
under the glare of television spotlights, Captains of Iniquity accused of behavior
befitting the most common of criminals. It's a distressing sight that has left the
investing public -- already the poorer for the excesses of Wall Street in the
'Nineties -- with little confidence in the integrity of the securities markets here. We
wondered about the view from abroad, and sat down for coffee with James
Clunie, the head of global equities at Aberdeen Asset Managers of Glasgow,
Scotland and overseer of about $2.5 billion in assets.
Clunie, who vaulted into the top
investing post at Aberdeen after its
takeover of Murray Johnstone in
late 2000, takes a top-down, often
thematic approach to investing,
scanning sectors across countries
and regions for a sense of the best
relative values. The aim for many
of their institutional portfolios is to
produce solid, low-risk returns that
consistently beat the Morgan
Stanley Capital International, or
MSCI, world index benchmark. So
far this year, the portfolios are
ahead of the benchmark by 2.5%
and they've bettered the benchmark
by small margins in each of past
three years.
In the higher risk country-allocation portfolios Clunie runs, he's beating the
benchmark by 7.7% this year. In 2001, he delivered gains that were 15% better
than the index's; that is to say, his funds were up 1.5%, while the Europe
Australasia Far East Index, or EAFE, fell 13.6%. Since October 1999, the
country-allocation funds have produced gains of 4.8% a year on average. For his
favorite countries and industries and some specific picks and pans, please read on.
-- Sandra Ward
Barron's: You just returned from a trip to Asia. What did you find?
Clunie: The evidence of domestic confidence and recovery in Korea and
Singapore, because their economies aren't fully dependent on exports to the U.S.,
is the stuff that leads us to want to stay overweight in South Asia and Korea and
North Asia. But Japan was most interesting. I talked to a real mix of companies,
mostly high-quality companies, many of them with very strong balance sheets and
a store of cash. They are nervous about the state of the economy and feel it is
necessary to have cash as a defensive posture. One or two were instituting stock
buybacks, but most were sticking with cash. They have already deleveraged and
have balance-sheet strength.
Q: What types of companies?
A: It was diverse, everything from medical equipment to pharmaceuticals, to soft
drinks, to consumer products. One of the most impressive was Kao, a company
that is very similar to Procter & Gamble in the U.S. or Unilever in Europe. They
are defensively structured but ably coping in a price-deflationary environment.
They have been monitoring price drops in their products and have been cutting
costs accordingly to raise profitability. If prices stabilized, they would still be in a
cost-cutting mode and that would drive profitability forward. In the meantime,
under tough conditions, they are still increasing profits and have good
balance-sheet strength. Management seemed very American in terms of the
techniques they use: EVA, or economic value-added analysis, product-profitability
analysis, stock options, share buybacks, all good traditional Western stuff. Kao is
a very impressive company.
Q: What others impressed you?
A: Terumo, a medical device maker that's been suffering price deflation in certain
areas like stents, or Banyu Pharmaceutical, which is effectively a division of
Merck and has been facing big price cuts instituted by the Japanese government
for its drugs, were both still able to boost profitability because of volume strength
and cost cutting. One or two companies, such as the car manufacturer Mazda,
still have high debt-to-equity levels, although they are moving to deleverage. Very
few companies are boasting about exciting new products that would require them
to borrow large sums to invest in. Japan's recovery will not be debt-driven. If
economic conditions stabilize, I expect companies to continue to cut costs
because that is what they are accustomed to doing. Altogether, it makes for a very
attractive profile of companies to invest in.
Q: How are they achieving the cost cuts? And how long can that go on?
A: Companies are demanding price cuts from suppliers. The automobile industry
has forced price cuts in the steel industry in Japan over the past few years, for
example. Toppan Forms, a printing company whose management we spoke with,
said they demanded better terms on the paper they buy and that became a major
factor in their cost-cutting program. But a second factor was reduction in staff,
long-term reductions based on natural attrition. These are multiyear programs.
Q: Are you increasing your exposure to Japan?
A: We are about 1% underweight Japan with about a 9.5% exposure in global
accounts. We are inclined to increase that to about 10.5% to be fully neutral with
the benchmark weighting. We didn't see any evidence of wholesale change in
price deflation trends or economic growth in Japan. There is a cyclical recovery at
the moment, based on global pickup, but there wasn't a strong message from
companies that business looked better and so there was no catalyst to go heavily
overweight in Japan, based on what we heard from a cross section of a dozen
different companies.
Q: What do you make of the market in the U.S.? What's your position in U.S.
stocks?
A: We're heavily underweight the U.S. For most institutional accounts, we are
10% underweight U.S. stocks and in aggressive accounts, we are 15%
underweight. The U.S. market is performing worse than most and the dollar is
poor. As the U.S. market declines, I would probably add a bit at the margin if I
could find the right ideas. But I can't find them, and that is the problem. I topped
off a bit of Home Depot recently, a high-quality stock that has dropped. I have
been buying GlaxoSmithKline, a U.K.-based drug company that is in many ways
effectively a U.S. company. The food and drink companies in the States, such as
Philip Morris and Anheuser-Busch, have done well by continuing to deliver steady
earnings growth. Two or three years ago, that sort of 10% earnings growth
looked very dull; now, it looks quite exciting.
But these stocks have run up an
awful long way and trade on quite
high P/Es [price-earnings ratios], and
many of them are quite expensive, relative to the rest of the market on a historical
basis. It is a mistake to buy them here at the margin, but I can understand why a
lot of investors are holding them and not selling: [The stocks] are continuing to
outperform. I'm using those kind of consumer staples as cash for new ideas,
selling defensive names to buy cyclicals in anticipation of an economic recovery.
The cyclicals are doing well, too. And to have defensives and cyclicals doing well
at the same time shows the kind of schizophrenic market we're in.
Q: What about consumer-finance companies?
A: Consumers are spending at a time when unemployment has risen and the
economy has slowed. One has to think that maybe the consumer should be a little
more cautious about life going forward. It might or might not happen, but it
should happen. Along those lines, some of the credit-card companies could be
vulnerable. We sold MBNA and bought Marsh & McLennan.
Q: Maybe your views on consumer spending are just the difference between the
Scots and the Americans.
A: Maybe I'm wrong. MBNA is a stock that has done well in an area that has been
fashionable, but going forward, with a yield of 1.1%, it is unlikely to remain as
buoyant. We'll see. Marsh & McLennan, while a financial-services company, has
some super brands, leading brands such as Putnam Investments and Mercer
Consulting, and it's off about 15% since April. It is the sort of stock you are quite
happy owning for the long, long term because of its brands and the staying power
they represent.
Q: What's your outlook on Europe? Intel cited soft demand from Europe when it
lowered its expectations recently.
A: Europe doesn't look too exciting. One positive is the euro's recent strength.
The question is: Where does it go from here? We are nervous about what it would
mean for European cyclicals if the European Central Bank raises rates sometime
this year. We have a neutral weighting in Europe, but the valuations are better in
Europe, and the currency looks more attractive.
Q: How do you approach companies from a valuation standpoint?
A: No single valuation metric can solve all problems. We tend to look at global
sectors and compare industries across countries. We visit companies and talk to
managements to gauge quality. We use cash flow return on investment analysis
and we use a number of tools. Within the pharmaceutical sector, for instance, we
look at P/Es and growth rates and P/E to growth multiples. But at the end of the
day, it all depends on the company's drug pipeline for the future.
Q: In early May, you were eyeing pharmaceuticals as a place to put money
possibly six months out, but you've been buying Glaxo lately. Can you talk about
the fundamentals there?
A: There was a scare a few weeks ago, when one of Glaxo's drugs lost a patent
battle that, presumably, it would have lost at some point in the future anyway.
That somehow shocked investors, and people began to question the company's
long-term growth prospects. There was a small-scale downward revision of
near-term growth and the stock price fell off a cliff. The recent flare-up about
taxes it might owe to the U.S. has been known and priced into the stock, and isn't
a big problem, but anything to do with taxes and accounting right now gives
investors another reason to sell. As an international equity manager who uses
EAFE as a benchmark, I know that Glaxo is 2% of EAFE, so it is a major stock
and it just fell from £16 to £13 in 10 days. I've been buying today, I was buying
yesterday, I was buying the day before -- buying a stock of a quality company
where there has been lowered expectations, but where there is quality. The
dividend yield is 3% now, and the company has a well-financed balance sheet.
Q: What about earnings growth?
A: Generally, the stock market's long-term earnings growth rate is about 7% a
year. Glaxo, because of its patents, should be able to grow faster, at say 10%. At
that rate, with a yield of 3% and a P/E around 16 for next year, it looked
reasonable to buy. That moves my drug weighting more toward neutral from
underweight, but I'm still underweight. The pharmaceutical stocks tend to have
sound balance sheets, are out of favor and still have some pricing power -- very
attractive in a world of low-pricing power, though that is a diminished theme
because of generic competition as drugs come off-patent and the erosion of
pricing power that follows.
Q: Where else are you seeing pricing power?
A: The paper and pulp industry has seen some good pricing, based on supply
discipline and consolidation in the industry.
Q: Do you have favorites in that group?
A: We like Stora Enso, which is a Finnish paper company, plus Weyerhaeuser in
the U.S. We've held Stora for about a year and a half, and it has been super. Its
American depositary receipts trade around 14, compared with about 10 when we
bought it. That's a gain of 40% when the overall market is down quite a bit. It was
obviously more reasonable a year ago, but with a dividend yield of 2.8%, pricing
power and supply constraints and a P/E of 17 or so, I think it is still reasonable.
Q: Is Korea still your favorite country, from an investment point of view?
A: Yes, we have a 4% weighting in Korea. It has rolled off a bit recently because
there has been some flight from risk and the emerging markets again. But stocks
like Kookmin Bank have been relatively firm though the market is down. Pohang
Iron & Steel, now known as Posco, which we also own, has gone up. We expect
continued outperformance from Korea based on the fact it is not expensive,
expectations still aren't too high and the domestic recovery can certainly run for a
while.
In the past few years, emerging markets in general have been discounted out of
fear of bad practices and bad treatment of shareholders. In Asia, there are lots of
stories about corruption and companies not doing what they are supposed to do.
But I read the same thing about companies operating in the U.S. now.
Q: How long have you held Kookmin Bank?
A: We sold Korea Telecom and rolled it into Kookmin about two months ago.
Kookmin's historic price-earnings multiple is 14 and its current P/E is around
eight. It looks cheap. It trades at two times book value, which is reasonable for a
bank. One highlight has been growth in domestic credit-card business as they
focus less on corporate loans and more on building the retail franchise. General
economic growth, low default rates, the interest-rate cycle and consolidation are
all positive sector trends.
Q: What's another recent favorite, anywhere in the world?
A: Prudential PLC in the U.K. It is a life-insurance company, it has some business
in Asia and in the U.S., where it owns Jackson National Life. Prudential PLC is the
dominant life insurer in the U.K. and its stock has been cut in half on poor
sentiment toward the whole sector. It's trading with a dividend yield of about
4.5%, a forward P/E of 12 and a price-to-book value of three. It's been hurt by a
series of scandals across the industry -- from misleading policyholders on
U.K.-oriented structured products and guaranteed investment products to a
shareholder revolt against its excessive executive pay policies.
Prudential has been one of the better companies in the sector only by way of
avoiding the worst of the scandals. There will be a regulatory catalyst at some
time, at which point the company will clear the decks and can be analyzed on the
fundamentals. There already have been management changes. Prudential is also a
big player in the savings industry and that has been hurt by the falling stock
market.
Q: What's your outlook on the U.S. economy? Are you looking for a double-dip
recession?
A: In the economy, no, though it has happened in the stock market. The economy
appears to be gradually picking up along regular patterns. But it is the mix that is
different from what people were expecting and they are finding it confusing.
People thought information technology spending would come right back, yet
[information technology] is in the middle of a multi-year overhang. The economy
is picking up and generally corporate profits will follow from that. But, in the U.S.
in particular, there is a corruption issue that's calling into question the integrity of
corporate earnings and undermining the very high expectations people had. We've
also just gone through a whole economic cycle, and the market didn't pick up,
which suggests we will have to go through another cycle before the market
recovers.
Q: At these depressed levels, are you attracted at all to technology or telecom?
A: Some of the telecom stocks look quite good. BT Group, known as British
Telecom, for example. They sold off their yellow-pages division. They've spun
out their mobile division. They had a big sale-lease- back on some properties.
They had a rights issue. They changed management. It's reducing debt and looks
like it is on its way to becoming a pretty easy-to-understand utility company.
Q: Do you own it?
A: Yes. I was quite an aggressive buyer earlier in the year. Six months ago, fund
managers were saying that BT was a busted telco with high debt and was on its
way out. In fact, they should have been buying it on the expectation that it was
going to become an easy-to-understand, high free-cash-flow company, paying
down debt.
Q: So you consider yourself a contrarian?
A: It is absolutely necessary to be contrarian in this investing environment
because it isn't a price-momentum market.
Q: How are your country portfolios working out?
A: They are the highest-risk portfolios we run -- top-down only, focused on those
countries we consider to offer the best investment potential. We get exposure to a
country by buying a basket of stocks, usually iShares, of those companies most
representative of the economy. It is a little bit cyclical, but the strategy is
completely brilliant right now. Year to date, the portfolios are 7.7% ahead of the
EAFE benchmark.
Q: What countries top the list now?
A: Hong Kong, Austria, Belgium -- little European value markets -- and Italy,
Germany and Spain. Earlier this year, Singapore and Australia did really well, and I
have since sold those. Austria is up about 20%, year-to-date. In many ways,
Austria is negatively correlated with the U.S. It struggled through the bull market
and now it's up double-digits while the American market is down 11%. The kind
of companies in the Austrian index -- Oesterreichische Postsparkasse, a bank;
Mayr-Melnhof Karton, a packing company; an airport company called Flughafen
Wien; and a steel company, Voest-Alpine -- are mid-cap companies and that's an
asset class that is really, really cheap.
Q: James, thank you very much. |
