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waterfall

Wellspring explorer

26 November 2014

Unfashionable stocks are often the source of deep value for fund manager Richard Oldfield, but require conviction and patience.

The late Canadian investor Peter Cundill every November would take a look back on the year to identify the nation with the worst-performing stocks – and then travel to that country in December to stock up on bargains. One year he might head Managua way and fill his portfolio with Nicaraguan companies; another could find him exploring the former Soviet empire’s Silk Road ‘Stans’. Investment manager Richard Oldfield recalls Cundill’s uncompromising investment style to highlight his own approach to finding underpriced but fundamentally sound stock. “We are reasonably deep value: Cundill was very deep value,” he explains. “He was braver. He was a very, very brave investor.”

Oldfield, who manages the St. James’s Place High Octane fund, also looks for companies that have faced a setback but are essentially sound businesses. Finding these wellsprings of future returns requires conviction and patience – and a dash of bravery too. However, there is a large body of research that concludes that a value approach increases the odds of good performance over the longer term, according to Oldfield. Certainly, in some years a value investor can look to be on the back foot and underperform, concedes Oldfield. But the key to the long-term success of the approach is in the timing of an entry into and exit from the market, and the selection of value stocks with sound fundamentals that offer the potential for future recovery and investor returns.

Stock racer

The automotive industry is an example of an unloved sector in which Oldfield has discovered value. Oldfield has invested in car companies only three times before his recent foray into the sector: in Chrysler during the 1980s; in Renault in the early 2000s; and in General Motors in 2005. Deterrents previously included high costs, union dominance in Europe, the fact that car manufacturers “consume capital like nobody’s business”, and the sector’s cyclical nature. “The only industry which maybe you could pick out as being even more unattractive is the airline industry,” says Oldfield.

But, for value investors, there are moments when the “upside is extraordinary”, adds Oldfield, who believes auto stocks, at present, offer this opportunity. Recent successes include Renault, Fiat, Toyota and General Motors. Oldfield believes the conditions in the car market are right for recovery: for example, the average age of an American car is 11.5 years, compared with the historic norm of 7; while in Europe sales are at rock bottom, and close to 1978 levels in Italy. “These conditions can’t and won’t last,” says Oldfield. Moreover, technological developments such as driverless cars should provide for a new wave of car sales over the next decade or so.

Deepwater horizons?

The oil & gas sector has provided Oldfield with deep pockets of value, too. Although BP has been on the back foot as it battles with the Deepwater Horizon oil spill, the total bill from environmental impact looks like it will be much lower than initial estimates in 2010. (Oldfield believes a gross negligence finding against BP for the Gulf Mexico disaster is unlikely.) BP’s stake in Russia’s Rosneft is also not the problem that some perceive, maintains Oldfield, with the holding’s $12 billion value a small proportion of BP’s total exploration and production, or ‘upstream’, value of $200 billion. “The quality of BP’s upstream resources drives the valuation,” he adds, asserting that the company is worth substantially more than its present value.

Russian oil group Lukoil was an acquisition at the end of last year. Rising production levels, a strong balance sheet and senior management share purchases are all positive signs for the energy group; as is a dividend yield of 7% and a commitment to increase these pay-outs by 15% a year. Oldfield concedes that political conditions in Russia can be “ghastly”, but, with two decades of investment experience in the country, he believes he knows how to navigate the “occasional grimness of the Russian scene”. Certainly, there are concerns over the escalation of international sanctions, including Washington’s restrictions on Russian companies, and Moscow targeting international investors. But, undervalued Lukoil shares are at a “whopping discount” to other oil majors.

‘Sleeping monsters’?

He describes the portfolio’s Japanese stocks as “sleeping monsters” with inherent potential and shareholder value, increased pay-out ratios through dividends and  share buy-backs. Japanese holdings include Mitsubishi UFJ, East Japan Railways, Nintendo and Toyota. Hitachi was recently sold when its share price improvement outpaced its fundamentals, but was a good example of “dinosaurs that can be prodded into life”.

Oldfield also highlights the turnaround of Japanese Airlines (JAL) under its entrepreneurial chairman Kazuo Inamori. It is attractively valued, with a price/earnings ratio of 5x against the 10–12x of its peers. “If an airline in Japan can start to achieve these levels of profitability and shareholder return, then all of these sleeping monsters in Japan have this potential,” he adds. However, if an idea does not work, Oldfield will readily admit he is wrong and extract himself from the position, as he did recently with Japanese group Canon. Nintendo is another Japanese stock that has come under recent scrutiny, as the group sits on large cash piles and its shares remain high. But, as the US stock market is at a historic high, Japan’s sleeping monsters have an allure for Oldfield and his value approach.

Richard Oldfield is the manager of the St. James’s Place High Octane fund.

The opinions expressed are those of Richard Oldfield and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.

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