02 Sep Market Comments
‘Effective September 2012, fourteen Franklin tax-free income funds will adjust the amounts of their dividends’ — down!
When I read this press release I couldn’t imagine why anyone today would invest in a medium to long term bond fund. After a 30 year bull market and near all-time record lows in interest rates, yields on bond funds have nowhere to go but up. The Federal Reserve is keeping rates artificially low, hoping to drive asset prices and consumer confidence higher until the economy can show some self-sustaining strength. When this happens, they will take their foot off the accelerator and bond prices will begin their long descent down. In contrast, after a 14-year bear market, stocks are reasonably priced and increasing their dividends.
You can make all kinds of arguments for or against the stock market, but the most logical is that stocks will continue to remain volatile until there is evidence that developed governments around the world are addressing their rising debt burdens. Most government debt can be reduced by various means, but a little money printing and inflation is probably the easiest method. Because stocks tend to represent real assets, they have a history of rising over time as inflation increases. This makes stocks the most logical choice if you believe your cost of living will increase in the future and you are attempting to maintain your ‘real’ purchasing power. As I mentioned in last month’s comments, there are a host of uncertainties in the global economy, but I am fairly certain bond investors are likely to be very disappointed if they expect their future returns to resemble anything like the past. As for today, I believe a diversified portfolio of exceptionally strong domestic and global companies, paying a reasonable and rising dividend and addressing a growing population of emerging and middle class consumers, can provide investors with a return they will be satisfied with. A little extra dose of cash also makes sense after the recent market run-up and uncertainties associated with the forthcoming election.
Top Holdings Notes — Walmart, Devon Energy
Walmart — 2nd Quarter Comments
WalMart reported an 8.3 percent increase in second quarter earnings per share on a 4.5 percent increase in consolidated net sales. Walmart U.S. comparable store sales rose 2.2 percent, Sam’s Club comparable sales, without fuel, increased 4.2 percent and Walmart International grew net sales 6.4 percent. Mike Duke, president and chief executive officer noted, “The paycheck cycle remains pronounced in the United States and in our International markets, given continuing economic pressures, we believe that our price leadership and value are growing in importance to customers across income levels”. Walmart returned $3.1 billion to shareholders in the quarter, which included $1.3 billion in dividends and $1.8 billion in share repurchases. Walmart delivered free cash flow of $6.1 billion for the six months ended July 31, 2012, compared to $4.0 billion the previous year.
Third Avenue Management — Devon’s valuation seems to be very compelling at about $9 per barrel of oil equivalent (“BOE”) of proved reserves. In 2009 and 2010 Devon sold its less attractive Gulf of Mexico and international operations at a price of about $45 per barrel of proved reserves. More recently, Nexen, a Canadian E&P company, agreed to be sold to CNOOC for about $19 per BOE of proved reserves. Although Nexen’s reserves are more heavily weighted to oil, Devon’s assets carry less development risk.
Oakmark Funds — Devon, with nearly 60% of its reserves in natural gas, is widely perceived to be a gas company, and its stock price has subsequently traded down with natural gas prices. However, 80% of Devon’s revenues and over 80% of our business value estimate stem from the company’s oil and liquids business. Based on our estimates, the stock is now trading at just over half of its 2013 asset value and we are not assuming any oil price recovery in our numbers. An additional reason we are attracted to Devon is the way management allocates capital. It seems that most oil and gas managements have a “bigger is better” mentality. Devon instead focuses on per-share value. In the past two years, Devon has used excess cash to reduce its share base by 10%. Selling at less than 10x expected earnings, at half of estimated asset value, and with a history of repurchasing its shares, we are pleased to add Devon to our portfolio.
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