How Brandes Works Part 1 Analysis
Ken Little: I’m Ken Little, Managing Director of the Investments Group here at Brandes. Our investment process begins with generating ideas for potentially attractive investment opportunities. These come from a variety of sources. It’s the job of our analysts to scour these sources and screen for undervalued companies by examining specific metrics relevant to the industries they cover. Brandes channels it analyst experience into seven global sector teams to focus on industries throughout the world. These teams are: Basic Materials. Consumer Staples. Financial Institutions. Industrials. Technology & Healthcare. Telecommunications. Utilities.
Altogether our research team consists of 25 research analysts, with an average tenure at Brandes of 13 years. Each team is led by a senior analyst with average tenure of 15 years with the firm. Key to the job of Brandes analysts is understanding the fundamentals of the businesses they cover. Last year alone the research team traveled more than 385 thousand miles researching the companies we invest in. Our analysts are from all over the world, and many from the countries that we invest in, such as, Mexico, Singapore, Brazil, Colombia, India, Japan, and China.
This keeps Brandes competitive in a borderless global investment arena. The bottom line is that each analyst develops a detailed understanding of the key drivers of the value of each company. As managing director, I’m fortunate to work with an amazing and diverse group of men and women and I’d like to introduce you to one of them: Mauricio Abadia.
Let’s talk about your experience and your role as a global research analyst within the Utilities group.
Mauricio Abadia: First let me start by talking about the investable universe. There are about 400 publicly listed utilities around the world that we consider to be investable given a sufficiently large market cap. And these are roughly split between developed and emerging markets. But to your question, about two decades ago, with deregulation of the industry, nowadays we have utilities with very different business profiles. Companies have both regulated and deregulated activities and also have very different regulatory regimes. So taking a fundamental, bottom-up approach is key to understanding these businesses.
The next step is to do the screen and that will vary by industry and analysts have very different ways to screen about names and in utilities what we found works best is looking at low price-to-earnings, low price-to-book and some specific industry- metrics such as enterprise value-to-regulatory asset base.
Of course these multiples can be a little bit nuanced because you have hedges in place and you have different accounting standards around the world which can disturb the multiples you see as provided by the data providers.
Ken Little: Is there any difference in how you look at emerging market utility companies compared to those of developed markets?
Mauricio Abadia: I would say our investment approach does not change whether we’re looking for a utility in developed or emerging markets. Our fundamental bottom up approach is consistently applied on a global scale. Having said that, to your question, I think that utilities may have proven fertile ground in emerging markets, because, first of all, they’re not the fastest growing companies; they’re not far off on the glamour spectrum so that I think the typical investors in emerging markets don’t necessarily gravitate to these types of names.
Ken Little: What else attracts you to specific utilities companies for further research?
Mauricio Abadia: I want to understand what is the sustainable earnings power of the company. And we want to rule out potential long-term changes to the business outlook of the company... If the stock’s price movement was driven by a short-term event or cyclical event in which we have good visibility that it might reverse at some point in time. That’s something that might be interested in looking at a little bit further. At the end of the day, we want to know is, when we look at a company, what is the long-term sustainable earnings power of that business.
Ken Little: So now you have a company in your sights, what is the next part of the process for you?
Mauricio Abadia: We’ll focus and try to spend most of the time trying to understand the particularities of that industry and of that businesses, and key-in on the key fundamentals that drive that valuation. That can be leverage, looking at the balance sheet, That can be profitability, as dictated by margins and returns and equity returns on capital. That could be cash flow conversion. That can be shareholder structure. And any other situation of the company that might be material.
Ken Little: Can you walk us through an example of a company in your sector?
Mauricio Abadia: Sure. One company is a multi-national utility domiciled in western Europe that is engaged throughout the entire energy value chain. In its current form, it has been around for the last three years but some of its predecessors can be traced back to the 19th century.
What we like about this company is is that it has a very solid cash flow generation, an A-rated balance sheet, and it’s returning cash to shareholders in the form of sizeable dividends.
The investment thesis on the name is that most of the parts of this business are performing ok. They have good profitability and stable businesses, but its deregulated activities in Europe are suffer a substantial decline in profitability. That is caused by the slow economy that we’re seeing in Europe. But also by the introduction of subsidized renewables by the incumbent operators of conventional thermo power plants.
We think it’s overly punitive to assume the company will continue to incur indefinite losses on this part of the business. We have to remember that at the end of the day the company retains the option to close down the plants or if not allowed by the regulators to least be reimbursed to cover the cash expenses.
That’s one area we might differ from how the market is looking at this part of the business on a more shorter-term focus.
On the other hand, the company has a large pipeline of projects in power generation and regulated activities that it is able to pursue in the many different countries in which it operates. And it also has the opportunity to continue to return cash to shareholders in the form of a sizeable dividends.
Putting all of this together, I come to the conclusion that the stock is being undervalued by the market and I think that it offers a very attractive risk-reward opportunity for us.
Ken Little: What is the final step in the process for you?
Mauricio Abadia: The analyst generates a report that contains a detailed description of the valuation, a description of the business, explains the economics of the industry and any other material fact that will assist the committee members to be able to arrive and determine an intrinsic value for that security.
Any discussion of specific securities is solely intended to demonstrate our investment selection process and should not be considered an offer to buy or sell any particular security. All examples discussed are for illustrative purposes only and do not reflect the investment experience of any client.
This is a hypothetical illustration of value investing concepts. It does not represent the performance of any specific security. It assumes changes over time. Actual results will vary.
*The investment team estimates intrinsic value for stocks using business valuation metrics such as price-to-book, price-to-earnings and price-to-cash flow ratios. For bonds, the investment team estimates intrinsic value using fundamental credit analysis.
**The Margin of Safety for any Security is the discount of the market price to our estimate of intrinsic value. Goal is to build portfolios with a high overall margin of safety.
Start Buying: Fundamental analysis identifies value opportunities.
Start Paring/Selling: Applying a consistent sell discipline, the investment team pares back on holdings as the margin of safety compresses and as the price moves towards intrinsic value estimates. There is no guarantee that a security’s price will reach our estimate of intrinsic value; further price declines are possible.
Sold: Holdings are sold as we no longer see value.
Price/Book: Price per share divided by book value per share.
Price/Cash Flow: Price per share divided by cash flow per share.
Price/Earnings: Price per share divided by earnings per share.
Past performance is not guarantee of future results.
This material is intended for informational purposes only. The information in this material should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings, or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. Portfolio holdings and allocations are subject to change at any time. Strategies discussed herein are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. Market conditions may impact performance
The foregoing reflects the thoughts and opinions of Brandes Investment Partners ® exclusively and is subject to change without notice.
Brandes Investment Partners ® is a registered trademark of Brandes Investment Partners, L.P. in the United States and Canada.