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THE DOW JONES BUSINESS AND FINANCIAL WEEKLY
INTERVIEW
www.barrons.com
OCTOBER 8, 2016
A Top Fund Makes the Value Case
The GoodHaven Fund rides the value resurgence with holdings like Barrick Gold, WPX Energy, and Leucadia National.
It’s been a rocky couple of years for
value investors, and that means it’s been
a rocky time for GoodHaven Capital Management’s Larry Pitkowsky and Keith
Trauner.
The co-portfolio managers founded
GoodHaven and its eponymous fund (ticker:
GOODX) in 2011 after leaving Bruce Berkowitz’s Fairholme Capital Management.
Pitkowsky and Trauner continued doing
what they had done for years: buy a concentrated portfolio of solid-but-beatendown companies and wait for the market
to recognize their value and reprice them.
Unfortunately, the market took its time,
and GoodHaven’s results suffered. After
beating the Standard & Poor’s 500 index
by 3.5 percentage points in 2012, the fund
underperformed the benchmark the following three years.
But 2016 has been just the kind of year
Pitkowsky and Trauner were waiting for:
Value stocks, particularly the out-of-favor companies they prefer, have enjoyed
a renaissance. The $268 million, 21-stock
GoodHaven Fund has returned 18% this
year through Oct. 5, well ahead of the
S&P’s 7.5% return. “Our job is to figure out
where the pockets of value are,” Trauner
says. “If we’re disciplined, we should do
just fine.”
In a recent conversation, Trauner and
Pitkowsky discussed the pitfalls of value
investing, the importance of sticking to
their knitting, and their stock picks.
afraid of. If you’re looking for a bargain,
you’ll find them there, not on the newhighs list.
Barron’s: What does value investing
mean to you?
Keith Trauner: We’re kind of genetically
wired to look at what people have been
What traits do you look for in a company?
Larry Pitkowsky: We like free cash flow
[the amount of money available to a com-
Keith
Trauner, left,
and Larry
Pitkowsky
“We’re back in an environment where stock-picking matters a lot,
and that plays to our strengths.“
—Larry Pitkowsky
pany after operating costs and capital
expenditures]. At the end of the day, you
want to see that cash has been generated
that can be spent on dividends, buybacks,
mergers, or reinvestment in the business.
Trauner: Capital allocation is important.
Management is responsible for two aspects
of the business: generating a cash return
(over p lease)
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By BEN LEVISOHN
for the owners and reinvesting the capital
generated. The really well-managed businesses of the world compound net worth
faster than those that aren’t.
Pitkowsky: We want to compound our
shareholders’ money as fast as we can without taking undue risk. The second part is
as important as the first part.
During the past few years, that hasn’t
been easy to do.
Pitkowsky: The opportunities change, but
not our process. If you are a value investor,
you will be out of sync with the market
from time to time. That tells us we’re doing
our jobs. Lumpy returns are the norm, not
the exception.
What has made your returns so
lumpy?
Trauner: There was an astonishing plunge
in energy stocks. If you had any exposure
to energy from mid-2014 to the end of 2015,
it was almost impossible not to get dinged.
Investor demand for safe dividend
stocks must have hurt, too, as they aren’t a staple of your portfolio.
Trauner: Companies perceived as safe,
with steady earnings, have become overvalued, without anything really changing
in their businesses. An emotional response
to the scarcity of yield has driven these
stocks. People have been reaching for yield
wherever they can get it. There has also
been a massive flow of money into passive
index funds, going into a relatively narrow list of securities. Buyers don’t know
whether they should be valued higher or
lower based on the fundamentals. That will
eventually be good news for a disciplined
value investor.
Pitkowsky: We’re back in an environment
where stock-picking matters a lot, and that
plays to our strengths.
Barrick Gold [ABX], your largest holding, at 12% of the fund, has more than
doubled this year. Other investors expected tough times for the company
and possibly a bankruptcy filing. What
did the bears miss?
Pitkowsky: Barrick was the pre-eminent
gold-mining company. It had the best reserves and properties in the industry. But
it got fat and did a stupid deal. It added
debt to buy copper miner Equinox Minerals for $7.7 billion at the top of the copper
market. It was a complete bust.
But that led to dramatic changes in
management. The board recruited chairman John Thornton, who was once a top
executive at Goldman Sachs. He laid out a
plan to reduce debt and costs, and focus the
company on free cash flow rather than size.
If you read some of the company’s filings
from late 2014 and early 2015, you think
you are reading a report from Berkshire
Hathaway.
Trauner: When John laid out his plan, we
were among the only people who believed
him at the time.
Pitkowsky: Barrick reduced staff at its
headquarters. Today there is no middle
management between guys that operate
mines and senior management. The company also implemented an incentive plan,
so people understood that their goal is to
maximize free cash flow per share, not
their empire.
Does the price of gold need to rise for
Barrick to work?
Pitkowsky: We’re not gold bugs. You’ve
got a sensible guy in charge of a talented
management team with some strong assets. They should be able to do OK even if
the price of gold doesn’t do very much. But
with even a modest rise in the gold price,
wonderful things can happen. Because of
Pitkowsky & Trauner’s Picks
Company / Ticker
Recent Price
Barrick Gold / ABX
$15.98
WPX Energy / WPX
13.49
Leucadia National / LUK
19.30
Verizon Communications / VZ
50.27
Source: Bloomberg
the cost reductions, there is a good chance
Barrick will be more profitable at a given
price of gold than at any point in its history.
Do you like WPX Energy [WPX] for similar reasons?
Pitkowsky: The decision to make WPX a
top holding, like Barrick, rested on a new
CEO, Rick Muncrief. We talked to people
who had worked with him over the years,
and we came away very impressed. The
timing was rough—it was a weak oil and
natural-gas market—but Rick executed a
slew of clever transactions to sell certain
assets and buy other assets. He completely
transformed the company.
Trauner: Getting these deals done at that
time was difficult. Muncrief and his team
repositioned the company under tremendous pressure, and did it without giving
things away.
Pitkowsky: Rick has emerged from this
difficult period with a company with better
assets, a better balance sheet, and a better cost structure. WPX is mentioned in
the same breath as the premier Permian
operators.
Does any of that matter if the price of
oil falls?
Trauner: WPX has hedged 80% of its oil
production at $60 a barrel. Next year it is
over 50% hedged at more than $50, effectively gaining a minimum price on a significant portion of production for the next 12
to 18 months. That ensures adequate cash
flow to weather the storm. There are no
material debt maturities until 2022.
What happens if oil prices rise?
Trauner: Rick positioned the company to
survive the downturn, and now he has positioned it to take advantage of any meaningful upturn in prices.
Pitkowsky: From now until 2020, WPX expects to grow oil production between 20%
and 35%, and cash flow between 20% and
35%. Net debt could be reduced by 2018 to
2.5 times Ebitdax [earnings before interest, taxes, depreciation, amortization, and
exploration], all with internally generated
money.
Leucadia National [LUK] has lost 2%
annually during the past five years,
even as the S&P 500 has gained more
than 15%. What is the attraction of
Leucadia?
Trauner: I bought my first shares of something that turned into Leucadia in 1986.
I’ve followed the business for an awfully
long time. It was founded in the late 1970s,
and they made money in most of what they
touched, which was usually deeply out of
favor and distressed in one way or another.
And their record over time was comparable
to, if not better than, Warren Buffett’s—until the financial crisis.
What went wrong?
Trauner: Leucadia is a conglomerate. It
owns National Beef, auto dealerships, a
plastics company. It has a significant investment in an Italian cellular carrier. And
after the financial crisis, Leucadia merged
with investment bank Jefferies. Most people have terrible problems trying to value
a company like Leucadia.
Pitkowsky: And both Jefferies and the beef
business had been underearning recently.
National Beef is the largest potential swing
in profits. It had been losing money and
now is poised to make a significant amount
of money.
In investment banking, bond trading
has been a terrible game for the past four
years, but it won’t be terrible always. Jefferies is uniquely positioned in banking and
trading. It isn’t big enough to come under
onerous bank regulations, but is much bigger than almost all middle-market competitors. It has built some important franchises
in investment banking, underwriting, and
bond trading in particular.
Why buy the stock now?
Trauner: We bought some earlier this year
at roughly 80% to 85% of tangible book
value, and even today it is trading at a discount. In the latest quarter the company
repurchased shares, which it has done very
infrequently. That is another sign the valuation is too low.
mobile competitive with fiber for many of
the most commonly used applications.
Trauner: Speeds are starting to get competitive with some of the weaker cable
companies. People aren’t going to give up
their phones; they are going to give up cable service.
You have a sizable stake in Verizon
Communications [VZ], which doesn’t
seem like a typical value stock. Why?
Pitkowsky: Verizon is a dominant business
providing a service that people can’t live
without. People would rather forgo heat,
hot water, and food than their smartphone.
Verizon has the best spectrum footprint in
the U.S. Its speeds are increasing, making
Are you worried about the loss of its
landline business?
Trauner: That’s a small part of the business, and decreasing every day; 90%-plus
of earnings are from wireless. On the other
hand, high-speed Internet access is more
protected. Verizon stands to gain share
from people who don’t have high-speed
packages and don’t require TV packages.
Pitkowsky: Wireless is down to only a few
competitors. Earnings aren’t too volatile.
There will be growth there, and there is
pricing power. A customer with high-definition channels and a decent cable package
could be paying $200, $300 a month. That
leaves room for Verizon to raise prices.
How does Verizon’s valuation look to
you?
Pitkowsky: The stock sells for 13 times
forward earnings and yields 4.5%. It appears to be a predictable, well-run business.
Thanks, Keith. Thanks, Larry.