Chris Semenuk's mission is stockpicking, and he travels the world to do it. The portfolio manager of TIAA-CREF's International Equity Fund (TIERX) looks for companies with performance-driven management that generate free cash flow. The 100 or so stocks in his fund must trade at a reasonable price compared with peers around the globe. Plus, he wants to have an "informational edge," which could mean easy access to top executives or knowing something about the company that's not being widely recognized or appreciated in the market.
Some companies that fit the bill include Bayer (BAY), his largest holding, as well as Accor (ACCP.PA) and Fiat (FIA.MI). These stocks have helped the $2.3 billion fund rise 18.9% so far this year and 33% for the last 12 months through July 19, beating the Morgan Stanley (MS) EAFE Index's 14% and 27% respective gains.
BusinessWeek.com's Karyn McCormack recently met with Semenuk, who has been running the fund since July, 1999, in New York. Edited excerpts from their conversation follow.
How do you select stocks?
I look for managements that are performance-focused. This means paying people based on annual and three-year targets, and benchmarking their business against the best in the business. Then typically, management that's very performance-driven has a business model that drives free cash flow above and beyond their needs, meaning enough cash flow to cover their capital expenditures and pay down debt or buy back shares or increase a dividend.
The valuation needs to be appealing within the sector globally. And hopefully, the company is not very well-covered, and we have a different view than the rest of the Street.
And the last one is important: Without having an informational edge, then the company won't get in the fund. The source of that edge can be we visit the company three or four times in a year or we just take a different view than everyone else has. You'd be surprised how much public information gets overlooked and is not carefully analyzed. But even if we think a stock has upside, if we don't feel like we have a different view than the rest of the Street, then the stock won't get into our fund.
What's an example of a stock that you own where you think you have an edge?
A perfect example is Bayer, a German chemical company. It's followed by chemical analysts. It's becoming more of a health-care company and less of a chemical company. Now, 60% of the company's earnings are coming from health care, but chemical analysts are still covering it. It's not being covered by pharma analysts either. The company trades at a discount not only to chemical stocks, but also to pharma companies.
Management has slimmed down its board, down from 15 to about four board members. Each board member oversees the divisions and are all very performance-driven. It made a prediction of almost $2 billion in cash flow even after they pay a dividend. So its business generates enough cash, which means it is running the business well.
It's the perfect model: It generates tons of cash, has a management that's very performance-focused, is undervalued vs. the sector, is not well-covered because it falls between the cracks of chemicals and health care, and has streamlined the board.
How much do you travel?
I travel a lot. That's where we find our ideas. It's really the only way to get out and see the companies. We don't make good decisions when we sit in front of our computers all day.
We don't buy broken businesses. We try to buy good businesses that, for whatever reason, are undervalued on a longer-term view. We're trying to do that with companies with good management and cash-flow model, and not a lot of companies qualify. If we can't get significant upside, then we'll let it go.
After you meet executives, how do you determine whether it's a good investment?
What feels right is if management sits in front of you and outlines their strategy with one slide in five minutes. That's what I should be able to do as a portfolio manager and that's what I tell my research team: If it's a really great idea, you should be able to explain it in one minute and hook me on it.
If we hear a performance-driven attitude, that cash flow is important, and they benchmark against other companies that they deem to be better than they are, then the stars start to line up. And hopefully the valuation is appropriate.
What's your sell discipline?
If a stock falls 10% after we bought it, then we need to ask questions because we clearly missed something. It forces us to not sit on losses too long. Most of the time, we'll sell it or sell a portion of it.
The biggest reason we sell a stock is another idea presents a better opportunity. We try to hold 100 names, and try to make sure the names compete against each other for capital.
Accor is another top holding.
Hotels are in the paper these days because Blackstone Group (BX) is taking over Hilton (HLT). Accor is a French global hotel franchise that owns a lot of budget, medium- and high-end hotels in Europe. It's known in the U.S. because it owns Red Roof Inns. Accor is headquartered in Paris and trades on a massive discount to anything else in the sector. It wasn't well-managed. Its cost base was high and had a lot of underperforming assets.
When we picked up that the company was about to name a new CEO, we talked to some of the people on the board. We found that Accor's earnings were coming from hotels as well as a voucher business. In Europe, it's very common for companies to give employees vouchers for lunch at restaurants located around the company's headquarters. Employees also use vouchers for train tickets and child care. Accor gets a fee for the vouchers.
People fail to understand its hotel business, but also that its voucher business grows 20% a year and has a gigantic market share. The voucher business is booming now. We found that the stock was trading at nine times EBITDA (earnings before interest, taxes, depreciation, and amortization). Right after that, Blackstone bought Hilton for 14 times. The whole company is even more undervalued if you take out the voucher business. The stock has worked well, and we continue to like it a lot.
You also own Fiat.
It first came on our radar because the company had three chief executives in four years. Back in 2004, Sergio Marchionne took over the job as chief executive. We had previously been invested in companies that he was the CEO of, and those companies worked very well for us. So we knew him. When he took over, Fiat was on the verge of going bankrupt. Our edge was we knew him. It was really an investment in him.
Marchionne is doing what he promised he would do. It didn't generate a lot of cash flow at the time, but they have businesses that were very capable of it; they were just not managed properly. He's extraordinarily performance-focused. He's targeting a 7% margin for the auto business alone. That's best in class, Toyota margins. Right now, they're only at 3.5%.
A lot of people associate Fiat with cars, but they also own Iveco and Case and New Holland, the third-largest tractor maker in the world. And Iveco is their truck business and that's done really well, given the good economy and there's huge demand for commercial vehicles. Marchionne tracks the auto business against Toyota (TM), the tractor business is against John Deere (DE) (which has a 9% margin), and the commercial vehicle [business] is benchmarked against Volvo. We think there's still huge upside in the stock.
What else in your portfolio is worth mentioning?
In Japan, we own 5202.T. Sheet glass is a commodity product used to construct buildings in Manhattan and for windshields in cars. Nippon Sheet was not very well-managed. It bought a British sheet glass company [last year] called Pilkington.
We've found that Pilkington management has infiltrated the Japanese business. They're the best-of-breed management; I think they'll fix the Nippon Sheet business. Sheet glass and cement are commodities that are very valuable. The glass business throws off a ton of cash, but we think the company should be better-managed.