Author: Jean-Luc Nouzille, Bristlecone Value Partners LLC
Covestor model: Large Cap Value
Disclosure: Long MMI, VMC, COV, DELL, CX, GD, INTC, S
In August, the model portfolio declined by 4.21%, outperforming the S&P 500 index’s 5.68% drop, according to Covestor’s calculations.
Investors are becoming increasingly pessimistic about growth prospects in the U.S. and the ability of European governments to solve the sovereign debt crisis within the euro zone. Long gone is the optimism prevalent last spring. We can’t help but think that the current negative mood greatly exaggerates the deterioration in economic and business fundamentals, but we also understand that pessimism can become a self-fulfilling prophecy, especially if companies start cutting back on investments and hiring.
During the month, stocks that contributed positively to performance were Motorola Mobility (MMI), Vulcan Materials (VMC), and Covidien (COV). The top detractors were Dell (DELL), Cemex (CX), and Sprint (S).
The positive contribution to performance from Motorola Mobility stock was due to a $40 cash acquisition offer from Google Inc. The stock price jumped far higher as a result in August and was by far our best performer. Google’s offer represents a small premium over our own estimate of Motorola’s value, which brings some validation to our valuation process. We’ve elected to hold on to our position for now (9/1), as the stock price remains at a discount to Google’s offer.
As is often the case, increased market volatility brought us more “fat pitches” to swing at: we increased our investments in Cemex, General Dynamics (GD), and Intel (INTC) in August as each stock was bid down to more favorable prices. Since we did not sell or reduce any positions, the cash position in the portfolio decreased. Of the three additions, Cemex definitely carries the highest degree of valuation uncertainty, due to a combination of financial and operating leverage.
Cemex’s core business (cement) is affected largely by construction activity around the world – but mostly in Mexico, the United States and Europe. Similar to the competitive strengths that we identified when we reviewed Vulcan Materials (https://investing.interactiveadvisors.com/?p=8516), we believe that high fixed costs and low value-to-weight ratio for Cemex’s products creates a strong competitive advantage for incumbents with large operations.
Although the company is currently experiencing a severe downturn, our valuation estimate is based on the assumption it will eventually return to a more normal construction environment in its core markets. Despite being in a weak financial situation, the company was able to renegotiate terms with its creditors in 2009, and has taken steps since then to reduce leverage and extend its debt maturities. The company’s assets are also highly marketable, and we feel that, absent a severe recession, the potential upside in the company’s stock warrants an increased investment.
