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Had his father's investment company

not employed a big-picture

approach to identifying attractive

stocks, Jay Bowen, armed with an English

Literature degree, probably would have

looked elsewhere for work in 1986. I'll

admit a bottom-up, number-crunching

approach probably wasn't for me, he says.The fit has turned out wonderfully for

Bowen, Hanes & Co. investors. The firm

now manages $2.3 billion and its longest-

lived equity portfolio has generated a com-

pound annual return of 14.9% since 1974,

vs. 11.8% for the S&P 500.

Keying primarily on trends tied to eco-

nomic globalization, energy and commodi-

ties, Bowen today is finding opportunity in

such areas as chemicals, water infrastruc-

ture, coal and railroads. See page 9

ValueInvestorFebruary 29, 2012

Art and ScienceNearly everyone today claims a global approach, but Sarah Ketterer has beeninvesting that way with considerable success for more than 20 years.

Inside this IssueFEATURES

Investor Insight: Sarah Ketterer

Scouring the developed world forbargains and finding them in Tesco,Western Union, Babcock & Wilcoxand Tecnicas Reunidas. PAGE 1

Investor Insight: Jay Bowen

On the prowl for prime beneficiariesof key global trends, which todayinclude DuPont, Xylem, CanadianPacific and Teck Resources. PAGE 1

A Fresh Look: WellPoint

As the companys business prospectsand performance have evolved overthe past year, so has Jed Nussdorfsopinion of its stock. PAGE 16

Strategy: Seth Klarman

Insight from an investing legend onhow right-thinking investors can bestmanage through today's dangerousstate of affairs. PAGE 17

INVESTMENT HIGHLIGHTS

Other companies in this issue:

AXA, Bank of Nova Scotia,BNP Paribas,

Canadian National Railway,Canadian

Natural Resources, Colgate-Palmolive,

Dresser-Rand,Harris Corp., JGC Corp.,

John Wiley & Sons,Kennametal, Molina

Healthcare, Munich Re, Nokia,PepsiCo,

PostNL, Procter & Gamble, Siemens,

Teradata,Timken,TransCanada,Zurich

Financial Services

Seeing the ForestTop-down investing is more in fashion since the financial crisis, but Jay Bowenand his father before him have been successfully using that strategy since 1972.

The Leading Authority on Value Investing

INSIGHT

INVESTMENT SNAPSHOTS PAGE

Babcock & Wilcox 8

Canadian Pacific Railway 11

DuPont 14

Teck Resources 12

Tecnicas Reunidas 7

Tesco 6

WellPoint 16

Western Union 5

Xylem 13

Sarah Ketterer has a simple answer for

why stocks in today's hyper-competi-

tive investing world can still, reliably

enough, become attractively cheap:

Nobody's patient anymore, she says.

Ketterer's calm in the face of market

storms has served her investors well. Her

Causeway Capital Management now man-ages $13 billion in assets and its global

value equity strategy has earned a net

annualized 10.5% since inception in 2001,

vs. 5.4% for the MSCI World index.

Combining quantitative stock screens

with detailed company research, Ketterer

and co-founder Harry Hartford are uncov-

ering bargains today in such diverse areas

as money-transfer services, grocery stores,

emerging-market capital spending and

energy infrastructure. See page 2

www.valueinvestorinsight.com

I N V E S T O R I N S I G H T

Sarah KettererCauseway Capital Management

Investment Focus: Seeks companies forwhich actual growth opportunities farexceed the myopic investor expectationscurrently built into the share price.

I N V E S T O R I N S I G H T

Jay BowenBowen, Hanes & Co.

Investment Focus: Seeks companieswith the most attractively priced stocks inindustries poised to benefit from what heconsiders key global economic trends.
http://www.valueinvestorinsight.com/http://www.valueinvestorinsight.com/

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2/21

I N V E S T O R I N S I G H T : Sarah Ketterer

Value Investor Insight 2February 29, 2012 www.valueinvestorinsight.com

Investor Insight: Sarah KettererSarah Ketterer and Harry Hartford of Causeway Capital describe how they invest differently in developed versus emerging markets, where they find the worst allocation of capital, how they risk-adjust their share-return expectations, andwhat they think the market is missing in Western Union, Tesco, Babcock & Wilcox and Tecnicas Reunidas.

How has international investing most

changed since you started out more than

20 years ago?

Sarah Ketterer: When I was setting up

Hotchkis & Wileys international equity

business in 1990, the most interesting

opportunities were in taking advantage of

the arbitrage between valuations that

appeared more rational and well-recog-

nized in the U.S. and those that were less

so overseas. International stocks were justgenerally less efficiently priced than

stocks in the U.S.

That gap between the U.S. and non-

U.S. developed markets has closed dra-

matically. One reason Causeway has

evolved more into global developed-mar-

ket strategies rather than international

only is because the opportunity set has

essentially become one. Money now

moves so fluidly between markets that the

historical differences between U.S. and

non-U.S. markets no longer apply.

What key inefficiencies remain for you to

take advantage of?

SK: The primary inefficiency is one of

time frame. Especially in the past five

years, with the frayed nerves of investors

after the 2008 crisis and with the contin-

ued rise of hedge funds, ETFs and com-

puterized trading, time frames have trun-

cated. Our investment horizon is three

years, give or take, which allows us toinvest with no obvious catalyst other

than mean reversion and a return to nor-

malcy. That works when nobody is

patient anymore.

Harry Hartford: There are a few types of

situations that typically attract us. It may

be in businesses that are cyclical and out-

of-favor and the market in our estimation

misprices the stock out of impatience or

an unwillingness to accept that the cycle

will mean-revert. It may be in businesses

where management has erred, say in over-

reaching with an acquisition, where we

believe the damage ultimately to be

incurred is far less than is currently priced

into the stock. Often its just that

investors move in herds and overinvest in

one part of the market say technology,

media and telecom stocks in the late

1990s leaving whole industries ignored

and very cheap.

In the past couple of years, for exam-ple, we have found opportunity in indus-

trial companies often with businesses

that are energy- or infrastructure-related.

These are companies that typically have a

heavy orientation to emerging markets in

Latin America, Asia and the Middle East,

but trade at modest European- or

American-market prices.

So a company like Siemens [SIE:GR],

maybe because its domiciled in Europe,

maybe because its had high-profile run-

ins with the authorities over past bribes,maybe because investors consider it an

unfocused conglomerate, trades at only

10x our earnings estimate two years out,

when, in fact, we believe its geared itself

to emerging-market transportation, ener-

gy and infrastructure capital spending

and has the capacity to generate signifi-

cant growth. Its well-managed, strongly

focused on returns on capital, has a very

underleveraged balance sheet and pays a

4% annual dividend yield. Thats the type

of story we find interesting.

How did you respond when investors

dumped European stocks en masse last

summer?

SK: We made the bedrock assumption

that the euro zone would remain intact,

primarily because the cost of a breakup

in our view would greatly exceed the cost

of funding peripheral sovereign debt. So

as investors fled European banks and

Sarah Ketterer

Not Far From the Tree

The daughter of prominent Los Angeles

investor John Hotchkis, co-founder of

Hotchkis & Wiley, Sarah Ketterer was less

than enthused by her first up-close expo-

sure to investment management. I spent

one summer in college filing tearsheets at

my father's firm,she says. It was so awful

I swore I'd never go back.

After an Economics degree from Stanford,

an MBA from Dartmouth and spending five

years in investment banking, Ketterer did

go back in 1990 to lead Hotchkis &

Wiley's initial foray into international equi-

ties. She held that position through the

firms 1996 acquisition by Merrill Lynch,

but decided in 2001 to partner with long-

time colleague Harry Hartford to launch

their own international money-manage-

ment firm, Causeway Capital.

I'm sure as a kid I had more exposure than

most to the world of equities, but once I

joined his firm my father made a point of let-

ting me ascend on my own or hang myself,

Ketterer says. I had plenty of people to talk

to and books to read which were invalu-

able but given how rapidly foreign mar-

kets were evolving, the best way to learn

early on was rolling up my sleeves and try-

ing to figure it out for myself.

8/2/2019 VII332

3/21Value Investor Insight 3February 29, 2012 www.valueinvestorinsight.com


insurance companies last summer, we

focused primarily on positions we

already held and stress-tested them for

the worst barring the implosion of the

euro zone including significant haircuts

on Greek, Portuguese, Irish, Italian and

Spanish debt. Not everything made the

cut we got out of Italys Unicredit

because we found the downside incalcu-

lable but when we concluded the

remaining companies had the potential

to survive in any type of apocalyptic sce-

nario, as value investors we had to step

up and buy more. That meant adding to

positions in banks such as BNP Paribas

[BNP:FP] and insurers such as AXA

[CS:FP], Munich Re [MUV2:GR] and

Zurich Financial Services [ZURN:VX].

We didnt bet the ranch on them, but wewerent afraid of them either. As a point

of reference, many of our competitors at

the time were buying consumer staples

companies.

Were classic value investors in the

sense that when share prices are low, we

think risk is low as well. Most people can

understand that in theory but dont

believe it in practice and even act as if its

heresy. Its actually when prices are rising

and stocks are converging with our share-

price targets that we find risk far moreuncomfortable.

Describe your research process in pursu-

ing ideas.

HH: Our quantitative team runs a variety

of value screens every week to identify

companies that are cheap within their

country or within their industry. That

output is made available to the research

team on Monday morning, which then

goes about trying to validate if the stocksare really cheap or not.

We always assign two people to look

into each security and the goal of their

fundamental research is to build a finan-

cial model that reflects the underlying

revenue streams of the business, the

underlying costs of generating those rev-

enues, the underlying costs of sustaining

those revenues through investments, and

any demands on cash flow from financ-

ing, taxes and capital allocation. From

that model we build a valuation frame-

work discounted cash flow, price to

book, normalized P/E, etc. for the busi-

ness that is independent of its geography

and specific to the industry in which it

operates.

That allows us to establish a two-year

price target for approximately 160 com-

panies on which well have done detailed

research at any given time. We use two-

year targets because we think beyond that

youre getting further into the realm of

speculation and have to start embedding

assumptions that are much harder to jus-

tify. We risk-adjust the expected returns

to our price targets, and use those risk-

adjusted returns as the road map to build

portfolios that typically hold 50 or so

securities in our global strategy and 60-70

in our international strategy.

How do you risk-adjust the expected

returns?

HH: We have an internal risk model,

which incorporates more than 80 factors

that contribute to the return profile of a

security over time, such as its industry, its

country of domicile, its currency, the

cyclicality of earnings, its valuation and

the price momentum exhibited by the

security over time. The model allows usto calibrate the expected volatility of any

security as a member of the current port-

folio, which is how we adjust the return

expectation to our two-year price target.

Our objective is to have a level of portfo-

lio volatility at or below the benchmark,

with return expectations that beat the

benchmark.

All else being equal, in a 50-stock

global portfolio well be allocating more

capital to the stocks at the top of the risk-

adjusted-return ranking and less to thos

further down the list. Thats usually sub

ject to a maximum holding in any one

security at the time of purchase of 5%.

SK: One advantage of having this type o

roadmap is that it constantly adjusts the

risk-adjusted returns as share price

move. As the price goes up, the return

expectation decreases and we adjus

position sizes on a regular basis to reflec

that. So while the stock of Molina

Healthcare [MOH], which is a managed

care provider focused on Medicaid

patients, was extremely attractive to u

on a risk-adjusted basis last fall, as it

price has more than doubled weve taken

profits and cut the position back dramat

ically. If the stock continues to outperform, it will continue to move down the

ranking a signal for us to sell unti

finally the stock has a zero weight in the

portfolio.

Youve historically steered relatively clear

of Japan. Why?

HH: We have been underweight Japanese

equities since we started, which reflect

our view that Japanese managers by and

large have been horrible allocators of capital. CEOs seem to have a time frame tha

far exceeds even ours, or believe their

employees are more prominent con

stituents than shareholders. While thi

type of mentality has changed consider

ably in Europe, its still a big problem for

us in investing in Japan.

We will find companies we like there

but they tend to be far more internation

al than domestic. One position of ours

today is in JGC Corp. [1963:JP], a lead

ing specialist engineering companyfocused on oil refineries and liquid-natu

ral-gas [LNG] plants, with nearly 80%

of its revenues generated outside o

Japan. It has an excellent balance sheet

benefits from growing worldwide

demand for LNG, and has a competitive

cost base off which to bid on large-scal

projects. While management isnt entire

ly Western in its approach, were quite

comfortable with its stewardship o

shareholder capital.

ON INVESTING IN JAPAN:

We have always been under-

weight Japan; Japanese man-

agers by and large have been

horrible allocators of capital.

8/2/2019 VII332



All value investors risk getting caught in

value traps. In what ways do you try to

avoid those?

SK: One general defense against value

traps is to by and large avoid product-

cycle businesses. You can have faith that

Nokia gets its act together in smart-

phones, or that Motorola returns to

prominence in handsets, or that the latest

device from Nintendo is a big hit, but we

think thats very tricky. For a company

caught in the headwind of a business

cycle, we can make assumptions about

recovery that we consider to be well-

founded. We believe were much less able

to make similar assumptions about future

product cycles.

Were also leery of industries withexcess capacity independent of the busi-

ness cycle. Were being very careful today

in the automobile industry, for example,

where theres still a lot of excess capacity

and stepped-up competition is coming

from China and elsewhere in Asia. We

will buy shares in a company like Toyota

after it had its recall problems, but that

was more a shorter-term valuation bet

than one on the longer-term prosperity of

the industry.

Describe how youre thinking about

PostNL [PNL:NA], which primarily

delivers mail in the Netherlands, from a

value-trap perspective?

HH: There is a technological obsoles-

cence aspect to the story, but the decline

in the traditional mail business is very

slow and the company has considerable

flexibility in adjusting its cost base in

response as that happens. On the other

hand, parts of the business such as high-er-margin parcel delivery are growing

around 10% per year. We also believe

considerable asset value, primarily in

PostNL's roughly 30% ownership stake

in express-delivery company TNT, creates

a floor for the share price.

SK: Last year the shares suffered less from

operational concerns than from the sover-

eign-debt crisis forcing the company to

divert money from dividends to add

money to its pension fund. We think the

worst is over on that front and that a nor-

malization in Dutch bond yields would

cause a re-rating of PostNLs shares

[which currently trade at just under

4.50]. Even getting to the valuation level

of the two other listed mail companies in

Europe, Austrian Post and Deutsche Post

which both trade at almost twice the

P/E multiple of PNL would result in a

significant gain in the stock.

You follow a different strategy for invest-

ing in emerging markets versus developed

ones. Describe that.

SK: We concluded that our value strategy

is more suitable to the developed world,

where investors reward undervaluation

and where earnings growth doesnt needto be present to catalyze a re-rating.

Thats in contrast to developing markets,

where investors are looking much more

for growth than value. For that reason

weve chosen for emerging markets to fol-

low a broadly diversified, quantitative

strategy that invests in more than 100

stocks across key markets.

HH: Emerging markets are undoubtedly

less efficient, so a quantitative methodol-

ogy meant to identify factors that indi-cate inefficiency should work better.

Valuation is still the primary component

we use, but we also include factors such

as earnings growth and estimate revi-

sions, as well as macro input such as bal-

ance of payments data and the slope of

the yield curve in the country of origin.

We want to exploit the entire universe of

opportunities that exist in emerging mar-

kets, not just the subset that a value man-

ager is able to find.

Turning to some specific developed-world

ideas, describe your investment thesis for

Western Union [WU]?

SK: This is one of the many U.S.-listed

companies we own that is far more

focused outside the U.S. Theyre in the

global money-movement business, prima

rily from people who have left their home

countries to seek economic opportunity

elsewhere and are sending money back

home to support their families. Its a sec

ular-growth business: According to World

Bank statistics, remittances sent to devel

oping countries reached $440 billion in

2010, up from around $160 billion in

2002. Other than a small drop in 2009

theres been a strong upward trajectory

the entire time.Western Union has some 475,000

agents around the world 70% of which

are located in high-traffic post offices or

banks, and 100,000 of which are in

China and India to facilitate those type

of transfers for a fee. So one basic drive

of our interest is that this is an ideal way

for our clients to get access to emerging

market income growth.

We also very much appreciate the

strength of the franchise. The company i

the clear market leader 4-5x bigger thanits next-largest competitor, MoneyGram

in an industry where size confers impor

tant advantages. The incremental cost o

processing a new transaction is minimal

so the largest network has far lower cost

on a unit basis, making it difficult for a

competitor to start a price war. Western

Union has also built an extensive and

hard-to-replicate compliance and lega

infrastructure to comply with a wide vari

ety of local rules and regulations i

spends more money on compliance everyyear than many competitors take in as

revenues. As a result of its franchise, the

company earns twice the operating mar

gins of competitors and its return on cap

ital is generally over 40%.

Theres also still plenty of room to

increase market share. The industry is stil

quite fragmented and the company is in

the best position to lead its further con

solidation. It also has much lower pene

tration in some geographic areas than i

ON EMERGING MARKETS:

We want to exploit the entire

universe of opportunities, not

just the subset a value man-

ager is able to find.

8/2/2019 VII332



likely to remain the case. By Western

Unions estimates the Asia-Pacific region,

for example, accounts for around 19% of

the global money-transfer market, but the

region accounts for only 9% of the com-

pany's revenue.

Why is the market not recognizing this

story as you think it should?

SK: The company isnt immune to trou-

bles in the economy, whether during the

global recession of a couple years ago or

more recently in Europe. Economic

weakness means fewer migrant workers

and less money transferred per transac-

tion. Those types of things can impact

quarterly earnings and the market can

overreact.

I think investors also are worried

about threats to the sustainability of the

business, whether from price wars, com-

petitors going after agents, or competi-

tion from new technology like mobile

payments. In general, we believe the com-

pany has a strong enough position that

traditional competitors will have a very

difficult time eroding its franchise. The

biggest risk we cant eliminate is mobile

payments, where people transfer money

using their cellphone. We tend to believe

that Western Union is likely to be part of

any viable solution offered on this fron

by telecom operators, but were watching

it very closely.

The shares, at a recent $17.80, have gone

nowhere over the past three years. What

potential do you see in them from here?

SK: This is one of our top positions based

on risk-adjusted return. Its not correlated

with much of our current portfolio and

trades at less than 10x our 2013 earning

estimate of $1.90 per share. The free cash

flow yield is close to 10%.

Assuming earnings growth in the mid

single-digit range and essentially stable

margins, our DCF model gives us a two

year price target of $33. That doesn

assume a recovery in the U.S. housingmarket, which would bring in more

migrant construction workers who are

heavy users of the companys services. Al

in all, the combination of strong share

price upside and such a unique and

defendable franchise makes this a very

attractive stock for us to hold.

Whats driving your interest in the U.K.s

Tesco [TSCO:LN].

HH: Tesco is the dominant player in U.Kgrocery retailing and has also expanded

aggressively in international markets

including big presences in South Korea

Thailand, Malaysia, Hungary and

Poland. It has modest market share in th

western U.S. through a small-grocery

concept called Fresh & Easy

Neighborhood Market.

This is a good example of what Sarah

was talking about earlier with respect to

investor time frames. The company

recently announced that it was revampingits U.K. strategy, somewhat away from a

single-minded emphasis on price and

more toward offering better quality. A

central thrust of that is an enhanced focu

on fresh food how much of it there is

how its displayed and how often it

replenished. Most of the investmen

behind this is going to take place through

the fiscal year ending February 2013, so i

caused analysts to pare back estimates fo

both this fiscal year and next. Consisten

Western Union(NYSE: WU)

Business: Largest provider of money-transfer services, executing nearly 20% ofinternational remittances through a globalnetwork of some 475,000 agent locations.

Share Information

(@2/28/12):

Price 17.7852-Week Range 14.55 22.03Dividend Yield 2.2%Market Cap $11.03 billion

Financials (TTM):

Revenue $5.49 billionOperating Profit Margin 26.1%Net Profit Margin 21.2%

THE BOTTOM LINE

The market is mispricing the companys unique and defendable franchise in a secular-ly-growing global industry, says Sarah Ketterer. Assuming annual percentage earningsgrowth in the mid single digits and basically flat margins, her DCF model yields a two-year share-price target of $33. If U.S. housing picks up, the upside would be greater.

I N V E S T M E N T S N A P S H O T

WU PRICE HISTORY

Sources: Company reports, other publicly available information

25

20

15

102010 2011 2012

Valuation Metrics

(@2/28/12):

WU S&P 500

Trailing P/E 9.7 15.8Forward P/E Est. 10.2 13.1

Largest Institutional Owners

(@12/31/11):

Company % Owned

Wellington Mgmt 10.9%T. Rowe Price 6.2%Vanguard Group 4.1%

State Street 3.7%BlackRock 2.7%

Short Interest (as of 2/15/12):

Shares Short/Float 2.4%

25

20

15

10

8/2/2019 VII332



with their focus on short-term earnings

momentum above all else, investors aban-

doned the stock, causing it to fall nearly

25% in the span of a couple weeks last

month.

So the first element of our thesis is that

the revamp in the U.K. represents a neces-

sary investment that will more than justi-

fy its short-term cost. On top of that, we

see tremendous latent earnings-growth

potential on the international side of the

business. Non-U.K. operations account

for roughly 40% of total revenues today,

but only about 20% of total profits.

Thats not surprising given that these are

faster-growing investment markets for

Tesco, but as these businesses mature they

will account not only for a higher share of

the total, but will also operate at highermargins than they do today. That type of

operating leverage should work its way

nicely through the income statement in

future years.

How inexpensive do you consider the

shares at todays price of around 3.20?

HH: The shares trade at less than 8.4x

our February 2014 earnings estimate of

38 pence per share. At about 25 billion,

the invested capital in the business

mostly real estate approximates the cur-

rent market cap, meaning the present

value of the companys cash flows are

barely being valued.

We think were being conservative in

using an 11x multiple on our fiscal 2014

earnings estimate to arrive at a two-year

price target of nearly 4.20. We dontconsider that a big stretch, given that the

stock spent much of the past year at o

near that level.

SK: Id add that the dividend yield here of

5.1% makes this a particularly appealing

value stock. Even if it takes longer than

expected to realize the earnings improve

ment, the healthy balance sheet means we

face little financial risk and were still get

ting the dividend. We think its just a

question of time for this to pay off. I

were early, so what?

You appear to have a like-minded share-

holder in Warren Buffetts Berkshire

Hathaway, which has a roughly 5% stake

in Tesco.

HH: We always say its nice to be in goodcompany.

Describe the unrecognized value you see

in Spains Tecnicas Reunidas [TRE:SM].

HH: Tecnicas is an international genera

contractor, mostly active in the engineer

ing, design and construction of industria

facilities for energy and power-generation

markets. Its domiciled in Spain, but the

Spanish market represents only 5% of it

order backlog. Overall, 37% of the backlog comes from the Middle East, 20%

from Latin America and 20% from

Europe (including Spain). Competitors

would include companies like Jacobs

Engineering and Fluor from the U.S.

Technip from France and Hyundai Heavy

Industries from South Korea.

How does Tecnicas distinguish itself com

petitively?

HH: Theres a sizable family ownership more than 30% and a byproduct of tha

is that the company is very risk-consciou

in bidding for major long-term contracts

That means its unlikely to be hurt by the

overly aggressive deal that can weigh fo

a long time on companies in this type o

business. At the same time, Tecnicas i

known for its ability to deliver very large

turnkey projects on time and within

budget. As you might expect, that means

a lot in this business.

Tesco(London: TSCO:LN)

Business: U.K.-based grocery retaileroperating roughly 5,000 stores in 14 coun-tries located in Western Europe, EasternEurope, Asia and the United States.

Share Information

(@2/28/12, Exchange Rate: $1 = 0.63):

Price 3.18

52-Week Range 3.11 4.23Dividend Yield 5.1%Market Cap 25.49 billion

THE BOTTOM LINE

Operating leverage as a needed U.K. store-investment program winds down and asinternational operations mature should work its way nicely through the companysincome statement in future years, says Harry Hartford. At 11x his earnings estimatefor the year ending in February 2014, the shares two years out would trade at 4.20.


TSCO PRICE HISTORY


4.50

4.00

3.50

3.00

2.502010 2011 2012

Financials (FY2011):

Revenue 60.93 billionOperating Margin 6.3%Net Profit Margin 4.4%

Valuation Metrics

(Current Price vs. TTM):

TSCO S&P 500

P/E 8.8 15.8

4.50

4.00

3.50

3.00

2.50

8/2/2019 VII332

7/21



Is a big part of the bet here on increasing

demand for energy infrastructure?

SK: This is not the only company we own

in this general area. As long as energy

demand is increasing a safe bet given

the continued rise of newly industrialized

countries we expect capital expendi-

tures required for the exploration, pro-duction, processing and transport of oil

and gas to continue to grow. That overall

growth is an important part of our invest-

ment thesis.

HH: Many natural-resource-rich coun-

tries in the past didnt do much with those

resources other than take them out of the

ground and ship them off. Over the past

10 years or so there has been a concerted

effort on the part of countries, particular-

ly in the Middle East, to extract addition-

al value-added from their resources

through some level of processing. That

trend isnt going away and is something

Technicas is positioned to exploit.

How attractive do you consider the

shares at a recent price of30.60?

HH: This is a project business, so the

stock often trades more on short-term

order flows than on the underlying

strength of the business. Were estimating

2014 earnings at around 2.90 per share

and believe a normalized multiple for a

business with this type of growth profile,

profitability and financial strength is

around 13x. After accounting for more

than 12 per share in net cash, our two-

year price target is 51 per share.

This is another case where the divi

dend yield of 4.4% is a big plus. As with

Tesco, were being paid to wait for the

valuation to improve as we think it will

Back on this side of the pond, why do you

believe Babcock & Wilcox [BWC] is mis

priced?

SK: This is a unique company, which was

spun out of oil-services firm McDermot

International in August 2010. Its primary

businesses are in supplying and servicing

nuclear components for the U.S. Navy

nuclear submarines and aircraft carriers

accounting for roughly 60% of total rev

enues and in building, maintaining and

retrofitting the coal boilers that generate

steam in utility power plants. Its a moredomestic business than many we own

with about 80% of revenues generated in

the United States.

The most exciting part of the business

is in meeting capital-spending demand

from utilities to retrofit coal-burning

plants to meet stricter environmental reg

ulations. That addressable market ha

been estimated at between $12 and $24

billion over the next five years. Given tha

Babcocks market cap is only $3 billion

getting even a modest share of that newbusiness can make a huge difference to

the bottom line.

We assume the market is concerned about

the high reliance on military spending

Are you?

SK: Given the growth expected in the util

ity business, the backlog tied to military

spending is closer to 40% of the total

rather than the 60% share it has of cur

rent revenues. While we dont expect thibusiness to grow rapidly, we actually see

upside for Babcock as it rolls out addi

tional components for the submarine and

aircraft-carrier programs it currently sup

plies. So rather than providing 10% o

the componentry in a nuclear sub, say

they believe they can take that to 20% or

even 30%. If theyre successful, even i

the pie shrinks somewhat which we

dont really expect to be the case theyl

compensate by taking a bigger slice.

Tecnicas Reunidas(Madrid: TRE:SM)

Business: International general contractorspecializing in the engineering, design and

construction of industrial facilities for theonshore production of oil and gas.

Share Information

(@2/28/12, Exchange Rate: $1 = 0.74):

Price 30.5852-Week Range 21.50 43.74Dividend Yield 4.4%Market Cap 1.69 billion

THE BOTTOM LINE

Given its risk-averse management, rock-solid balance sheet and reputation for on-timeand on-budget project delivery, the company is well-positioned to benefit from highglobal demand for energy-related infrastructure, says Harry Hartford. At 13x his 2014

earnings estimate, after accounting for net cash, the shares would trade at 51.


TRE PRICE HISTORY


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Financials (9 mo. ending 9/30/11, annualized):

Revenue 2.66 billion

EBIT Margin 5.8%Net Profit Margin 5.0%

Valuation Metrics

(Current Price vs. TTM):

TRE Russell 2000

P/E 12.5 41.3

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HH: One important thing to note about

this defense franchise is that the mainte-

nance of the nuclear-submarine fleet and

installation of new equipment is only ever

going to be done by an American compa-

ny, and Babcock has a virtual lock on the

business. That adds considerably in our

view to the stability of the business going

forward.

Weve seen much discussion of the com-

panys mPower nuclear-reactor technolo-

gy. What are its prospects?

SK: We arent putting a value on it

because its not completely through

research and development, but it is cer-

tainly a promising technology that could

have huge demand. Its a small mobile

nuclear module for power generation,

which allows for adding capacity in

smaller increments to meet load-growth

projections and has the potential to pro-

vide a safer, more contained nuclear-gen-

eration process. Its too early to say its a

game-changer, but it does provide a nice

call option on the upside.

After falling for much of last year, the

shares have recovered somewhat to a

recent $26.10. What upside do you see

from here?

SK: Making what we believe are conser

vative assumptions for the utility busi

ness to grow at only GDP plus 1% and

for the military business and margin

overall to be relatively stable, we arrive

at a discounted-cash-flow value two

years out of nearly $41. The balance

sheet has net cash and while theres no

dividend yet in this case, its certainly no

beyond the realm of possibility tha

theyll institute one.

The most problematic risk would be a

wholesale pullback from current required

environmental regulations, so that utili

ties wouldnt have to spend as much with

Babcock on retrofitting their plants. We

consider that extremely unlikely, but it i

a risk.

What on the macroeconomic front do

you think investors may not be worried

enough about today?

SK: One concern we always have but tha

is especially relevant in todays environ

ment is protectionism. Countries facing

difficult times can increasingly turn to

political demagogues whose answer is to

close borders and shun internationa

trade. Those taking that road will become

pariahs in the global debt markets, andany exposure we have in those areas or to

companies that rely on trade with them

would be at severe risk.

Are you of the mind that the marke

volatility weve had over the past few

years is just something well have to get

used to?

SK: I look at the 2008 global financial cri

sis as a generational event, which fol

lowed a long period of credit creationthat had to come to an end. I'm not sur

prised that 2009 did not mark the end o

the crisis, and aftershocks have occurred

in heavily-indebted Europe. But these are

all phases, and volatility will return to

long-term averages. For now, however

were able to find very profitable invest

ments by taking advantage of short-term

ism and of the masses of investors with

no more than a goldfishs memory of pas

market cycles. VII

Babcock & Wilcox(NYSE: BWC)

Business: Manufacture and servicing ofutility, industrial and military power-genera-tion systems that utilize nuclear, fossil-fueland renewable energy sources.

Share Information

(@2/28/12):


Financials (TTM):


THE BOTTOM LINE

Overshadowed by its larger division serving the U.S. military, the companys utility-related business is poised to grow rapidly due to demand for plant retrofits to meetstricter environmental regulations, says Sarah Ketterer. Based on her discounted-cash-flow analysis, the two-year price target for companys shares is nearly $41.


BWC PRICE HISTORY


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Valuation Metrics

(@2/28/12):

BWC S&P 500



(@12/31/11):

Company % Owned

T. Rowe Price 17.7%

Mason Capital 12.0%Primecap Mgmt 8.0%

Shapiro Capital 5.3%Vanguard Group 3.9%



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I N V E S T O R I N S I G H T : Jay Bowen


Investor Insight: Jay BowenBowen, Hanes & Co.s Jay Bowen explains why hes particularly enamored with stocks in Canada, what companies heexpects to benefit from an industrial renaissance in the U.S., the development that would dampen much of his long-termoptimism, and why he believes Canadian Pacific Railway, Teck Resources, Xylem and DuPont are mispriced.

Your strategy is driven more by the analy-

sis of big-picture themes than company-

by-company specifics. Why?

Jay Bowen: The firm since my father

started it in 1972 has always taken a top-

down approach. We begin with a broad

analysis of global macroeconomic, politi-

cal and technological trends, the objective

being to determine how these trends will

impact specific industries and companies.

Our view is that if we can get in front ofbig trends and position our portfolios in

sectors with the most secular growth

potential, were better setting ourselves

up to add long-term value. There are

plenty of ways to invest successfully

ours is not the only way and it certainly

isnt always successful, but its worked for

us over a long period of time.

Give an example showing how you move

from the top on down in your analysis.

JB: There are typically several pieces to

the puzzle. Were very focused today on

Canada, for example, based on a variety

of political and economic trends. The

government is pursuing economic

reforms that we believe will keep it on a

path with higher growth, lower unem-

ployment and a stronger currency than

will be possible in the U.S. Theyre cutting

corporate taxes, reducing federal debt as

a percentage of GDP and consistently

moving higher on country rankings ofeconomic freedom.

With that favorable economic-policy

backdrop, Canadas abundant resources

and best-in-class companies serving glob-

al commodities markets also make it ide-

ally suited to benefit from growing secu-

lar demand for natural resources in an

industrializing world. Once weve made

these types of broad conclusions, its then

a question of finding the best ways to

play them. For us today that translates

into holdings in commodity producers,

such as Teck Resources [TCK] in coal,

copper and zinc and Canadian Natural

Resources [CNQ] in oil and natural gas.

It means holding railroads like Canadian

Pacific Railway [CP] and Canadian

National Railway [CNI], and pipeline

companies like TransCanada [TRP]. It

even supports our position in Bank of

Nova Scotia [BNS], one of our few finan-

cial holdings, which has the tailwinds of

being in Canada without the regulatoryheadwinds that U.S. banks face and

which we fear could turn them more into

utilities than thriving business enterprises.

Once focused on an industry, how do you

select individual companies to own?

JB: Our top-down work is meant to

uncover not just absolute trends, but

those which we also believe will happen

faster or with greater magnitude than

anticipated. For that reason we generallyexpect the companies in a given target

industry to perform better from a growth

and profitability standpoint than what

appears to be priced into the stocks. So in

many ways picking individual stocks at

that point turns for us into an in-depth

relative-valuation analysis.

If we get the asset class right, the coun-

try right, the sector right and the industry

right, we believe were really at least 90%

of the way there. The truth is that if were

interested in Deere [DE] and Caterpillar[CAT] each of which we own theres a

good chance both are going to do pretty

well. When choices have to be made, we

go with the better value.

While we certainly dont have a black-

box approach to stock selection, were

typically buying companies that have P/Es

based on our forward earnings estimates

that are below the market, earnings

growth rates based on our estimates that

are above the market, current dividend

Jay Bowen

Compounding Power

Two years after Jay Bowen's father, Harold,

co-founded Bowen, Hanes & Co., the firm

landed a prized client, the Tampa, Florida

Pension Fund for Firefighters and Police

Officers. The pension fund invested $12.1

million on September 30, 1974, starting a

remarkable long-term relationship that pro-

vides an object lesson in the power of

compound returns.

Tampa's portfolio consists of both stocks

and bonds, although Jay Bowen, now

CEO of the firm, says the fixed income por-

tion is managed mostly for income and sta-

bility, so has more or less matched its

benchmarks. The overall portfolio's outper-

formance, then, is due primarily to the fact

that over more than 37 years it has earned

on common stocks 3.1% per year more

than the S&P 500, 14.9% vs. 11.8%.

The bottom-line result of that outperfor-

mance? Even after more than $600 million

in net withdrawals, Tampa's assets with

Bowen, Hanes have increased to more

than $1.5 billion. The 3.1% per year alpha

in common stocks has resulted in 2.75

times more money from equities than

would have been generated by investing in

the market index. Not a bad way to build a

long-term client relationship.

8/2/2019 VII332

10/21

yields and 10-year dividend growth rates

that are above the market, and foreign

revenues that are at least 50% of the

total, with an emphasis on emerging

rather than developed markets.

Is the dividend emphasis relatively new?

JB: We have been paying much more

attention to dividends over the last couple

of years. In this interest-rate environment,

where consistent dividend payers are

yielding more than government and cor-

porate bonds, the demand for higher-

yield stocks should continue to go up

from investors looking for income. The

long-term record for dividend payers is

impressive: One study from last year

found that from 1972 to 2011, when the

S&P 500 returned 6.8% per year, sharesof companies that didnt pay dividends

returned 1.2% annually, while those that

initiated or grew dividends over that peri-

od returned 9.1%. We think were in a

period in which the share of total return

coming from dividends is likely to revisit

the high levels of the 1950s and 1960s.

Youve made the case for a multi-year

industrial renaissance in the U.S.

Describe that.

JB: One of the most important trends

were looking at is our belief, triggered by

the shale-energy revolution, that over the

next ten years its possible that the U.S.

overtakes Russia and Saudi Arabia to

become the worlds top oil and gas pro-

ducer. That would have a significant

impact on our entire manufacturing base,

as a result of lower energy input costs and

the heightened activity around the devel-

opment, production and transportation

of all the oil and gas.The tentacles are long with something

like this. The CEO of Nucor, the steelmak-

er, is talking about building lower-cost

natural-gas-powered plants that can pro-

duce the same amount of steel with about

one-quarter of the capital needed for a tra-

ditional coal-powered plant. You have

lower production costs, lower input costs,

savings for the customer and less emis-

sions, making it a win-win for jobs, indus-

try and the environment. In places like

Ohio, investors have committed $2 billion

to shale operations in the state and the

French company Vallourec is spending

several hundred million dollars to build

production capacity for pipeline infra-

structure. Those types of investments can

transform a struggling Rustbelt state, and

play out over and over again elsewhere.

What companies do you consider particu-

larly poised to benefit?

JB: Some of the Canadian firms I men-

tioned earlier, including TransCanada and

the railroads, would be big beneficiaries.

As would companies like Dresser-Rand

[DRC], which manufactures and services

equipment that is primarily used in the

exploration, production, processing and

transportation of oil and natural gas.

Even though their stocks have been fairlystrong lately, we also still like the long-

term prospects of machinery and equip-

ment companies like Kennametal [KMT],

which makes a variety of tooling and

engineered products used in industrial

production, and Timken [TKR], which

makes bearings and related products used

by original-equipment manufacturers.

You own several consumer packaged-

goods companies. Whats the thematic

element there?

JB: Weve always had a solid representa-

tion in consumer-products and food com-

panies, such as PepsiCo [PEP], Colgate-

Palmolive [CL] and Procter & Gamble

[PG]. Part of that is our view that they will

incrementally benefit from the more rapid

economic growth in developing markets,

but we also like that they pay healthy and

growing dividends and provide a cushion

to the portfolio during sharp downturns.

Given that we usually have high cyclica

exposure, that defensive component ha

helped us over the years.

Every single holding isnt going to tie

into a global, thematic trend. For exam

ple, we own John Wiley & Sons [JW/A]

the book publisher, for no other reason

than its been a solidly growing niche

company that has consistently delivered

over the years and is attractively valued

Were not overly active in technology, bu

weve done very well with Teradata

[TDC], which has a variety of proprietary

enterprise computing solutions that we

think provide a long-term play on cloud

computing. In this case, we also believe i

could prove to be an interesting takeove

candidate, so its somewhat of a specia

situation in that regard.

Do you have any portfolio rules or guide-

lines on things like position sizing or

industry weighting?

JB: We really dont. On individual posi

tion sizes, our core positions at cost tend

to be of relatively comparable weight

we dont try to distinguish that one idea i

20% better than another so we should

have 20% more of it. As for industry and

sector weightings, we are aware of the

level of exposure we have, but have rarelyfound it necessary to pull back in any one

area because we considered ourselve

over-exposed. One thing we do pay atten

tion to is an individual position becoming

too large. If a stock gets beyond 5% or so

of the portfolio, well usually take some

profits and scale it back.

Elaborate more specifically on why you

find Canadian Pacific Railway to be so

compelling.

JB: Railroads have been an important par

of our portfolios for years and this one fit

nicely into any number of powerful top

down themes. With direct links to eight

different ports in the U.S. and Canada

including Vancouver and Montreal

Canadian Pacific benefits directly from

continued expansion in global trade. I

plays a key role in the energy supply chain

in Canada and the northern U.S., serving

key resource areas such as the Bakken for



ON U.S. RENAISSANCE:

Within ten years its possible

the U.S. overtakes Russia and

Saudi Arabia as the worlds

top oil and gas producer.

8/2/2019 VII332

11/21

mation, Marcellus shale, Alberta oil sands

and major ethanol production areas in the

U.S. Midwest. It is a big player in soft

commodities such as grain and fertilizer,

serving the expanding global agricultural

trade. Also, after heavy investments in

infrastructure, the company has a major

presence in intermodal shipping, which

has increasingly become an efficient and

cost-effective option for more and more

companies.

From an industry perspective, we

expect the operating leverage and pricing

power exhibited by railroads in recent

years to continue. That is especially true if

high oil and gasoline prices persist, which

enhances the cost-efficiency argument for

railroads over truckers. We even consider

railroads an attractive inflation hedge,

given how theyd benefit from growth in

demand and prices for natural resources.

What makes this particularly interest-

ing is the potential here for an operating

turnaround. Canadian Pacific under its

existing management has long been a per-

formance laggard relative to its primary

competitor, Canadian National Railway,

which has been a core holding of ours for

many years. That underperformance has

prompted a proxy fight by Bill Ackman of

Pershing Square Capital, who wants to

install five new board members as well as

a new chief executive, Hunter Harrison

who is a former CEO of Canadian

National. Canadian Pacific shareholder

are scheduled to vote on Ackman's nomi

nees at the annual meeting in May.

We take it youre not backing current

management.

JB: Theres a compelling case for change

and we think the company is going to lose

the proxy battle. Hunter Harrison say

theres no reason Canadian Pacific can

move its operating ratio [operating

expenses divided by net sales] from a cur

rent level of 78% to closer to the 65%

Canadian National realized while he was

running it. Thats a realistic five-year goa

and Harrison is ideally suited to lead theturnaround you dont have to speculate

about whether he can pull it off because

hes done it before.

The shares have rallied since Pershing

Squares entry into the picture and now

trade at $75.25. What upside do you see

from here?

JB: We assume that over the next five

years revenue can grow by around 6%

annually. If the proposed operating-ratiogoal is met, that would translate into

around $10 in per share earnings five

years out. At a reasonable 14x multiple

that would get us close to a double in the

share price.

The lower operating ratio would also

give the company more cash to reinvest in

the business or return to shareholders in

the form of dividends the current yield

is 1.6% or share buybacks. That would

be another plus if they can pull it off.

Staying in Canada, whats driving your

interest in Teck Resources [TCK].

JB: We spoke earlier about our bullish

ness on global commodity demand

which will benefit Teck as a major pro

ducer of coal, copper and zinc. The more

specific driver of our interest, however, i

coal, which accounts for 50% of the com

panys revenues and which we believe i

poised for a period of significant growth



Canadian Pacific Railway(NYSE: CP)

Business: Class I railroad operator haulingshipments primarily of intermodal contain-ers, grain, coal and fertilizer in Canada, theU.S. Midwest and the U.S. Northeast.

Share Information

(@2/28/12):


Financials (TTM):


THE BOTTOM LINE

Jay Bowen believes the company is not only well-suited to capitalize on several keyeconomic trends, but is also ripe for an operating turnaround currently being instigatedby Pershing Square Capital. Assuming 6% annual revenue growth and that proposedmargin goals are met, he believes the shares can reach $140 within five years.


CP PRICE HISTORY


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Valuation Metrics

(@2/28/12):

CP S&P 500



(@12/31/11):

Company % Owned

Pershing Square Capital 14.2%Artisan Partners 5.1%Wentworth, Hauser & Violich 4.4%

Royal Bank of Canada 3.9%BMO Capital 3.0%


Shares Short/Float n/a

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What really caught our attention was

last Decembers United Nations confer-

ence in South Africa on climate change,

which couldnt agree on a replacement for

the existing Kyoto Protocol agreement

that will remain in place until 2020. That

means theres no binding long-term glob-

al agreement limiting greenhouse gas

emissions, which we consider a bullish

scenario for coal producers.

Another key point is that the Chinese

domestic coal industry has been unable to

keep pace with surging demand from its

steel industry for metallurgical coal. For

the country to achieve an efficient, stable

coal-based infrastructure, it is going to

have to rely on significant imports over

the next several years. While Australian

coal miners will be obvious beneficiaries,

we believe demand will be high enough

for Teck already the second-largest

exporter of metallurgical coal in the world

to benefit as well. It has the capacity to

significantly increase its annual output of

metallurgical coal and can do so at rela-

tively low capital cost. It doesnt hurt its

prospects in China that the companys

largest shareholder, following a 2009

forced recapitalization, is the sovereign

wealth fund China Investment Corp.

On the thermal-coal side, all our

analysis points to strong global demand

as new coal-fired electricity generating

capacity is installed worldwide over the

next several years. Were keeping a partic

ularly close eye on Japan, which is expect

ed to move sharply away from nuclear

power following last years Fukushima

disaster. That will likely lead to signifi

cant import demand from Japan for coal

Is anything particular of note going on

elsewhere in the company?

JB: Demand for both copper and zinc

should primarily benefit from expanding

GDP growth in emerging markets

Copper probably offers the most poten

tial for revenue growth, as the company

has several advanced-stage projects enter

ing production over the next five years.Another kicker, which is not a genera

tor of revenues or profits today, is Teck

Frontier oil-sands asset located in the

Athabasca region of northeastern

Alberta. They recently bought out their

partner on the project and appear very

committed to bringing it on line. Its al

quite speculative at this point, but if i

happens at anywhere near the scale pro

jected, it could account for a meaningfu

portion of the companys market value

within the next ten years.

Trading at around $41, how inexpensive

are the shares?

JB: Earnings are likely to be volatile, but

we believe with all the secular tailwinds

can increase at a low- to mid-teens annu

al rate over the next five years. Tha

would result in $7 to $8 per share in earn

ings, which at even a 10x multiple would

result in close to 100% appreciation from

todays price.This has not been a stock for the fain

of heart, but one big positive is that the

company has significantly repaired it

balance sheet through asset sales and by

raising equity over the past three years

Long-term debt is now something like

25% of total capital. That allows us to

more confidently focus on long-term

supply and demand trends that we

expect to work very much in the compa

nys favor.

Teck Resources(NYSE: TCK)

Business: Diversified mining companyfocused on commodities such as coal, zinc,copper and lead, with primary operations inCanada, the United States, Chile and Peru.

Share Information

(@2/28/12):


Financials (TTM):


THE BOTTOM LINE

While company earnings may be volatile, Jay Bowen expects them to grow at a low- tomid-teens annual rate over the next five years, primarily driven by strong global demandfor coal and expanded copper production. Applying a 10x multiple to his estimate of$7-8 in EPS within five years, the shares would increase 75-100% over that time.


TCK PRICE HISTORY


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Valuation Metrics

(@2/28/12):

TCK S&P 500



(@12/31/11):

Company % Owned

China Inv Corp 17.5%BlackRock 8.9%RBC Global 3.7%

I.G. Inv Mgmt 2.2%TD Asset Mgmt 2.2%


Shares Short/Float n/a

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8/2/2019 VII332

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Water is a commodity you havent yet

mentioned. How is it driving your interest

in Xylem [XYL]?

JB: Xylem is one of three businesses that

ITT Corp. broke itself into last October.

We had been long-term shareholders in

ITT and Xylem was the only piece we

decided to keep it is the highest-quality

asset and the most interesting from a the-

matic standpoint.

The company provides a full spectrum

of products for the transportation, treat-

ment and testing of water, serving public-

utility, industrial, commercial, residential

and agricultural markets. It operates in a

large, fragmented global industry in

which big conglomerates tend to be

involved, including GE, Siemens andPentair. Xylem is the largest pure play,

but while 65% of its revenues come from

overseas, it currently is only available to

service maybe 10% of the nearly $300

billion global market for water equip-

ment and services. That gives an indica-

tion of the potential we see for it.

What water-related themes do you con-

sider tailwinds here?

JB: In developed markets, demand islargely driven by the need to replace

crumbling infrastructure, the need for

enhanced pump systems to move water

from more distant sources, and the need

for more sophisticated testing and filtra-

tion systems to meet environmental regu-

lations. To give one example, there are

estimates out there that 60% of the U.S.

water infrastructure should be replaced in

the next ten years, at an estimated cost of

approximately $1 trillion.

In emerging markets, more rapidgrowth is driven by infrastructure spend-

ing required by increased urbanization

and by the general need for enhanced

water systems for industrial, commercial

and residential users as economies grow

and populations expand. U.S. water

demand tripled in the last 30 years, while

the population grew only 50%. As a sim-

ilar dynamic plays out in China which

has 21% of the worlds population but

only 7% of its fresh water you can see

how ready access to water is an ongoing

problem that solutions providers like

Xylem will be tasked to address.

Beyond purely economic demand,

there is also significant need from a pub-

lic-health perspective to enhance clean-

water availability. More than one billion

people today live without decent access to

clean water, making death by treatable

water-borne diseases one of the scourges

of the third world. Were not holding out

Xylem or others in the industry as having

answers to all these problems, but its

clear to us that their ability to provide

technologies and solutions to make things

better will be in high demand.

The shares, at $26.85, are up nearly 15%

since the spinoff. How are you looking at

valuation today?

JB: Driven by both strong top-line growth

and margin expansion from operating

leverage, we believe the company has a

good chance to compound earnings at a

low double-digit rate over the next five

years, to around $3 per share. Put a nor

mal market multiple on that and the stock

would trade in the mid-$40s.

While thats not an eye-popping

prospective return, wed expect it to out

perform the market and also see potentia

catalysts on the upside. One would be

Value Investor Insight 13February 29, 2012



Xylem(NYSE: XYL)

Business: Recent spinoff from ITT Corp.offering a broad spectrum of products andservices supporting the transportation,treatment and testing of water worldwide.

Share Information

(@2/28/12):


Financials (TTM):


THE BOTTOM LINE

Its sole focus on water-related equipment and services positions the company to ben-efit from significant demand drivers in both developed and emerging markets, says JayBowen. Putting a market multiple on his EPS estimate five years out, the shares wouldtrade in the mid-$40s. A naturally higher profile would provide added upside, he says.


XYL PRICE HISTORY


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(@2/28/12):

XYL S&P 500



(@12/31/11):

Company % Owned

Barrow, Hanley, Mewhinney & Strauss 7.0%Vanguard Group 5.2%State Street 3.6%

BlackRock 3.0%T. Rowe Price 2.3%



30

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from multiple expansion as the earnings

numbers come in and the stock generates

more institutional interest on Wall Street.

Since the spinoff Xylem has had a very

low profile we typically like that when

establishing a position, but we expect it to

change as the company prospers.

In addition, theres a very good chance

that this fragmented global industry

becomes less so as the leaders look to

consolidate market share. Wed never

own it for just this reason, but I cant help

but think at some point Xylem would

make a very attractive acquisition for a

larger industrial company looking to

expand its water business.

Describe your investment case for

DuPont [DD].

JB: We consider DuPont somewhat mis-

understood. It operates in a variety of tra-

ditional chemicals businesses tied to con-

struction, electronics and plastics, but

what attracts us is that 75% of its capital

and R&D expenditures are allocated to

segments that we believe have very strong

growth prospects. Its evolving more into

a high-tech science company and away

from a cyclical chemical company.

At a broad level, its geared nicely toglobal economic growth, with operations

in 80 countries, 60% of revenues coming

from outside the U.S., and 35% of rev-

enues specifically in emerging markets.

While its getting out of businesses like

car paint which could bring in more

than $4 billion in a sale it continues to

expand in strong secular-growth busi-

nesses like agricultural commodities and

alternative energy.

The agriculture business provides

hybrid corn and soybean seeds under thePioneer brand name and also sells herbi-

cides, fungicides and insecticides. Global

food demand is estimated to increase

70% by 2050, with an increasing percent-

age of calories consumed globally coming

from corn- and grain-fed animal prod-

ucts. Given that the amount of unfarmed

arable land around the world is limited,

the only way to meet that increased

demand is through improving crop yields

on existing farms, which is what Pioneer

is all about. Its the oldest and largest seed

company, has been capturing market

share from competitors on a consistent

basis since 2008, and has a strong

pipeline of new products coming out over

the next few years.

Another key growth area for DuPont is

providing materials and systems for pho-

tovoltaic products used in the solar indus-

try. It has key strategic relationships with

many of the top industry manufacturers

and has been an innovator in helping

advance solar-module performance.

Management has set a goal of $2 billion in

sales into the photovoltaic market by

2014, up from $1.4 billion today, and we

think thats reasonable given the still-rapid

growth in solar installations globally.

There are other areas with energy, envi

ronmental, nutrition and health applica

tions that have intense R&D and acquisi

tion support. As these markets expand

innovations are commercialized and

acquisitions assimilated, we see potentia

for significant incremental returns.

How does all that translate into upside

for the stock, now at around $51.40?

JB: We believe the company can increase

earnings per share to $6.50 to $7 over th

next five years, which would result in



DuPont(NYSE: DD)

Business: Global chemicals producerserving markets including agriculture, nutri-tion, electronics, communications, con-struction, transportation and apparel.

Share Information

(@2/28/12):


Financials (TTM):


THE BOTTOM LINE

The companys evolution beyond its cyclical industrial-chemical roots is not well rec-ognized by the market, says Jay Bowen. Bolstered by growth in such areas as agricul-ture, alternative energy, health and nutrition, he believes earnings can grow as much as10% per year and that the shares within the next five years can reach at least $90.


DD PRICE HISTORY


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102010 2011 2012

Valuation Metrics

(@2/28/12):

DD S&P 500



(@12/31/11):

Company % Owned

State Street 4.5%Capital World Inv 4.0%Vanguard Group 4.0%

BlackRock 2.5%JPMorgan Chase 2.4%



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above-average annual growth in the 9-

10% range. At the same time, on consen-

sus 2012 earnings estimates the stock is at

only 12x earnings, less than the estimated

13x at which the S&P 500 trades.

Put a 13-14x multiple on our long-

term earnings projection, and the stock

price would be around $90. On top of

that, the shares now pay a 3.2% yield a

70% premium to the 10-year Treasury

and the company has a history of increas-

ing dividends at an above-market rate.

When your thesis proves faulty, does it

tend to be more of a problem with the

company, or with the trend you were

counting on.

JB: Either can certainly happen. We hadowned communications-equipment sup-

plier Harris Corp. for many years, but

concluded late last year that its revenues

were more at risk from government

spending cuts than we were comfortable

with, and that management just didnt

have as solid and cohesive a business plan

as we wanted. We also recently sold

Nokia after concluding that while the val-

uation was seemingly interesting, we had

been excessively enamored with the divi-

dend yield and also underestimated the

negative impact on margins and earnings

from commoditization in the handset

market. Can they innovate around that?

Maybe, but it wasn't a bet we were will-

ing to make.

How did your strategy hold up in 2008

and 2009?

JB: We certainly suffered much of the

pain everyone did, but one advantage we

have is that our average client has been

with us for close to 20 years. They valueand share our long-term perspective, and

were willing to ride through that period

with us. That gave us the luxury of not

having to liquidate holdings at exactly the

wrong time, which positioned the portfo-

lio well to come back as quickly as it did.

Most of the trends youve discussed are

positive ones. What worries you the mos

on the downside?

JB: My biggest concern is that the U.S

doesn't get its fiscal, monetary, and regu

latory-policy house in order to suppor

economic growth. The federal budge

deficit and national debt are trending to

levels that will have dire, long-term eco

nomic and social consequences if no

reversed. We need a policy regime tha

not only reduces the burden of govern

ment spending, but also increases the

incentives for work, risk-taking and capi

tal formation.

I'm optimistic, but there is a risk we

don't learn from Europe and Japan

whose policies on a variety of fronts haveproduced economic lethargy. If that hap

pens and we keep trying to muddle along

as we currently are at the policy level

our portfolios will have to have a dra

matically different complexion than they

do today. VII


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With details about healthcare reform

more solidly on the table, Jed Nussdorf of

Soapstone Capital a year ago saw good

news on the horizon for managed-care

giant WellPoint [VII, February 28, 2011].

In particular, he expected the reform act's

inclusion of Medical Loss Ratio [MLR]

minimums to create an incentive for

providers to push plan pricing higher,

resulting in a hard market that could

last at least through 2013. The result

would be better-than-expected earnings

for WellPoint and significant upside in theshare price, then at $66.50.

All proceeded well, as relatively strong

insurance prices and a benign medical-

cost environment bolstered the results of

WellPoint and competitors such as

UnitedHealth and Aetna. Through June,

WellPoint's stock traded above $80. At

that point, however, Nussdorf started

hearing of pushback on pricing from bro-

kers and clients who were loathe to

accept big increases when medical costs

were running lower than usual. While hedidn't expect pricing to turn soft, the

change in sentiment after a strong run in

the stock prompted him to sell roughly

one-third of his WellPoint position.

The more concerning news hit with the

Q2 2011 earnings report, which indicated

that problems in areas such as the compa-

ny's Medicare preferred provider organi-

zation business and in its California com-

mercial lines would keep it from enjoying

a banner year. The sun was shining,

says Nussdorf, but WellPoint wasn'tmaking hay. On that news, with the

shares around $70, Nussdorf sold more

of his stock taking his position to 20%

of what it had been last February.

As the performance gap between

WellPoint and its top competitors has

widened as measured by its Medical

Loss Ratio Nussdorf has become more

disillusioned. In September he wrote a let-

ter to the company's board detailing why

he believed current management should

be removed. In particular, he fears that

when health-insurance exchanges upend

the status quo for managed-care providers

starting in 2014 shifting responsibility

for buying insurance from employers

more to individuals WellPoint will be as

woefully out-executed as he believes it

has already been in the comparable

Medicare Advantage market.

Why hold the stock, now around

$65.50, at all? Despite its home-grown

problems, he says the company remains

the low-cost provider with the highestlocal market shares through its dominant

Blue Cross/Blue Shield network. It also

has earnings leverage which could make

today's share price look exceedingly

cheap. If WellPoint's MLR got within 100

basis points of the level achieved prior to

current management taking over, he says

the company would earn close to $12 per

share this year. Were it to catch up and

match the membership growth its peer

realized over the past five years, earning

power would be as high as $15 per share

There's still an opening for the com

pany to get back on track, he says. The

upside if that happened is big enough thait's worth maintaining at least a smal

position for now. VII

Addition by SubtractionInvestors always have to assess whether news about a company is noise to ignore, or something important on

which to act. For Soapstone Capitals Jed Nussdorf, it's been more the latter for WellPoint than the former.

A FRESH LOOK: WellPoint


Share Information (@2/28/12):

Price $65.5452-Week Range $56.61 $81.92

WellPoint(NYSE: WLP)

NEW BOTTOM LINE

Some pushback on plan pricing and poor company execution has led Jed Nussdorf tocut his share position by 80%. He maintains a stake because the upside is consider-able probably under new management if the company were to get back on track.

ORIGINAL BOTTOM LINE FEBRUARY 28, 2011

The investment thesis for the company, says Jed Nussdorf, has shifted from a why itwont be so bad focus to a more offensive why it will be good one, based onincreased pricing power. At 12x his estimate of what will then be the next twelvemonths earnings per share, the stock 18 months from now would trade around $100.


WLP PRICE HISTORY


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WLP S&P 500


VII, February 28, 2011
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Value Investor Insight 17February 29, 2012 www.valueinvestorinsight.comwww.valueinvestorinsight.com

Editors Note: We always invest fully

prepared for adverse scenarios to

unfold, writes Seth Klarman in his latest

Baupost Group annual letter to investors.

Careful followers of Klarman in the 30

years since he founded Baupost know

that to be true, as his long-term,

absolute return oriented, value investing

approach spans a broad range of asset

classes, hedges liberally, puts primary

emphasis on margins of safety and typi-

cally holds a high cash balance in excess

of 33% on average across his investment partnerships since 2001. All that while

generating long-term net returns that are

the envy of the industry. In these excerpts

from his just-published letter, Klarman

examines the precarious macroeconomic

environment investors face today, key

challenges facing the U.S. and how to

overcome them, insights from behavioral-

finance expert Daniel Kahnemans new

book, and why he believes investors

should not be single-mindedly focused

on bad news.

Today's dizzying and daunting market

volatility is driven by astonishingly short-

term investor thinking. Over the course of

2011, the S&P 500 Index fluctuated 2%

or more on 35 days (based on closing

prices many more if you include intra-

day moves) only to end up almost exactly

where it started. Some days, an economic

green shoot emerges, and investors fanta-

size a bumper crop and buy. Other days,

the news is disappointing, and investorssell. On really bad days, investors fear the

world may be ending, that our problems

of excessive leverage and undercapital-

ized banks will never be solved, and

urgently unload. Then, one or more gov-

ernments or agencies take action nearly

always with freshly printed money or

cost-free guarantees or hint that they

are about to, and investors decide the

world will survive one more day and

jump back in. A crisis erupts, followed by

intervention that staves it off for the

moment. Another crisis, another quick

fix, or vague promises of one. We are

truly in uncharted territory. Official gov-

ernment policy in the U.S. and Europe

essentially consists of economic and mon-

etary whack-a-mole, targeting immedi-

ate symptoms but never the root causes.

Pretend and extend reigns, no prob-

lems are ever fully solved, and the future

is endlessly mortgaged and re-mortgaged.

While we insist on investing based on

what we see, many seem determined to

commit capital based on the muscle mem-ory of what things used to be like or on

the undying hope for a full-bore recovery

that never seems to arrive. The knee-jerk

response of many investors to each suc-

cessive crisis has been to anticipate a

quick fix and buy the stock market's dips.

Stocks that have declined 10% or 20%

may be cheap certainly they are cheap-

er than they were but it is much harder

to know if they are cheap enough: cheap

enough to withstand an economic double

dip and the resultant poor earnings;cheap enough to hold their valuation

should corporate profit margins revert to

their historic mean, or worse; and cheap

enough to still be glad you bought them

after they trade a lot lower.

The absence of yield in the developed

world is unpre

vii332

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