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http://www.valuewalk.com/2011/10/exclusi...tom-russo/
By Jacob Wolinsky, October 24, 2011
Thomas Russo overseas over $6 billion as a general partner of Semper Vic Partners and Semper Vic Partners(Q.P) limited partnership along with overseeing in discretionary individually managed accounts for individuals, trusts and endowments. Russo graduated from Dartmouth College (BA, 1977) and Stanford Business and Law Schools (MBA/JD, 1984).
Russo’s Semper Vic Partners fund has returned a cumulative 2,754.9 % versus 979.9 % for the S&P 500.
1. Can you briefly describe the concept of global value investing and who influenced you?
Tom Russo: I have several billion dollars under management, which I invest in global equities. It was for the longest time a style that was not practiced by anyone. It was global, not local or international, so that was already confusing to most consultants. And then there was a long-term focus with taxable investors in an effort to abide by Warren Buffett’s advice to invest long term and then harvest the profits from that over a lifetime. This is a very unusual aspect of what we do and it is mainly unusual because most people cannot abide by doing nothing for long periods of time. Most people find the working environment leads them to do something, so they are much more active than the necessarily need to be.
So I would say global and unusual. It is less so now, though. There are more people in this world of global investment. We see the incredible rise in relevance of non-US investments because of the relative growth in GDPs around the world. I was drawn into this style in the early 1980s. The concept of international came to me through Stanford Business School when Professor McDonald, who taught my investment class, said “Do not be provincial.” Ninety-Five percent of the world does not live in the United States. Figure out a way to make investments that recognize the promise of that 95 % of the world. That happens all the time. The US market was far bigger than any of the other markets, and we had a higher GDP than relative to the world now, but over time the advice to go abroad early in my career has made all the difference in my career.
2. What is your approach to value investing?
Think about the goal of investing, which stems from the value approach of Warren Buffet. That is to find 50-cent dollar bills. That is an okay approach. It is hard enough to do, but it is an okay approach if you find 50-cent dollar bills and you are indifferent to taxation and you can somehow close out that discount quickly.
I think you do not really care about the dollar bill very much if you are like me, since as a long-term investor what you really want to do is find a 50-cent dollar bill that will grow over the years. And it is that growth component that provides the returns. We have been fortunate to harness the power of such growth through our international franchise. Buying dollar bills at 50 cents provides a measure of safety. Finding strong companies whose owner (mimics?) management, and is capable of investing to grow that dollar bill (underwritten?) for future returns.
3. What do you define as a powerful brand? Is it a moat?
Tom Russo: Nestle is our largest position, followed shortly by Phillip Morris International. We also own Richemont, which is a Swiss Company that has global brands such as Cartier and Dunhill; Heineken, which we first invested in 1989; followed by SABMiller, which I added to my portfolios in 2009; followed by Pernod Ricard, which I invested in probably 2003.
All of these businesses have powerful goodwill associated with their global brands. And it is the ability that they have enjoyed over the past 25 years to increasingly exploit that goodwill in growing parts of the world because of the rise of consumerism and the rise of open markets that has given our portfolio a really strong tail wind.
Additionally, it is the fact that the management of those companies is very often guided by the wishes of their founding families and owners that have made the investment decision. I think by those managements, better in terms of guidance and advice from owners than the traditional American Company has, where so often management reigns without constraint by any kind of owner-mindedness.
And so we have had the privilege of global brands to invest behind by managements who are encouraged to make thoughtful owner-minded investments by the fact that the company’s founding families are still involved in my portfolio to a most unusual extent.
When management makes those investments, they must have the capacity to suffer. They have to suffer during the start-up period of those investments because they are not necessarily linked to at the hip with the Wall Street expectations of smooth and steady quarters, but they are able to withstand the burden of the investment cycle. It is inevitably certain that profits are low or non-existent during these early years. And if you do not have the capacity to suffer through that period, you will shy away from making the accurate amount of investment. Your management will under-invest at a time when they have set an advantage and will allow competitors to come into the market.
I think having family-owned businesses at the helm of our companies in many instances has stretched out our management’s horizon. It has given more courage to invest even when the reputed earnings of our company may be temporarily burdened by start-up losses from these investments.
4. Do you think going international has given you a strong lead against other investors?
Tom Russo: I think that going international has given us an enormous leg up because we have increased the number of brands that we get behind, we increased the management focus on owner-mindedness and we increased the capacity for them to invest. I can give you a bunch of examples of how I think our portfolio companies are better today because during periods of time when there is competition, they do not shy away from making investments because of their burdens on income statements. Our companies stay the course, suffered through those early burdens and effects on their income statements or report of profits. And then our companies have enjoyed the wealth that has grown from that capacity to suffer.
As an international (investor in?) brands, for managements have been well positioned for markets that have opened up over the past three decades. I have exposed us and our business to substantial population growth in the developing and emerging markets in the developing and emerging markets and also new populations if you think about places like India and China, which were closed to our companies just two decades ago. They now represent nearly three billion consumers to which we actually market products.
5. Can you give examples of the pricing powers of these companies?
Tom Russo: I think our businesses have shown over time that they have pricing power which is because of the strength of the brand. That is extremely important long term because it is that pricing power that accompanies a product’s perceived indispensability in the minds of the consumer that allows our business to raise prices in sufficient amounts to offset the pressure of commodities and inflation.
And a good example of this occurred when I was once on a plane. I had a colleague sitting next to me in an airplane who ordered a Jack Daniel’s and the steward came back and said “I am sorry. We only have Jim Beam,” to which he said, “No thanks, I would rather have water.”It is that kind of consumer loyalty that means that the brands have power—if the steward came back and said “Yes, you can have Jack for a dollar more than Jim Beam” he probably would have paid. We want to make sure we have businesses that have that pricing power.
I think by and large we just found that and the pricing power is particularly important in the developing, emerging markets because they enjoy rising consumer disposable income. Nestle and Unilever, which are two large holdings, understand that they have to go into the markets early on with popularly-priced products that are either a different variation of their Western market products or are simply sold in different packet sizes.
By using the popularly-priced product, they are able to have the price that the consumer can afford at the start and as that consumer has more disposable income, they can introduce multipacks, which increase the consumption or they can introduce more of a premium package to products which drive the aspirational consumer forward.
6. Is it important for consumers to adopt a global perspective?
I think by having an early introduction to the non-US markets as early as 1982 and by my business school professor to not be provincial, that I have gained an edge. I have had—through that global outlet, enormous opportunity. And the thing is, if you adopt a global perspective, I think in terms of population growth, pricing power, and volume growth and all of those things. But it also allows an investor who is focused on a handful of industries like myself; mainly the food, beverage, tobacco and media to stay focused. It allowed me to keep my capital more employed during those periods of time when industries such as the ones I have mentioned became overvalued in their home market. So in 1986, for example, When KKR took over RJR Nabisco, and most food and beverage companies have pretty high-sized valuation because of the belief that the next leveraged buyout would come along and increase the values, I found better values abroad.
At that time, I was able to make continuing terrific investments in Heineken and a breakfast cereal company based in England in 1986 and 1987. I was able to purchase shares in both at single digit multiples, whereas in the US, because of RJR and the takeover fever that ensued in the mid-1980s, the multiples were often twice as high in the US.
Having the outlet to deploy your capital in that handful of businesses by keeping a global perspective meant that I did not have to go to find other places to invest other than the businesses that I admire just because companies’ share prices had gone up to an inflated level as a result of the takeover activity.
Lastly, you know, if you ever sort of wonder global is the hunt for value of—the other thing that has happened is that at least in the industries I participate in, it is almost impossible to think about conducting fundamental research on consumer product industries without having a global perspective.
When I started in the 1980s, the three Japanese brewers were the largest in the world, and over time the Anheuser-Busch became slightly larger than them, but you cannot have a view on global beer if you are forced as an investor to only focus on the US beer companies.
In the areas that I tend to find of interest (food, beverage, beer, spirits, tobacco, etc) the global aspect is a by-product of the research process as you are forced to consider global competition. There is a competitive step that occurs when you are making investment decisions about relative valuation and if you are going to look back at competitors like Heineken instead of Budweiser. If Heineken has a better business, better brand, more disciplined investment process than Budweiser—you should certainly not limit your portfolio to just the best American brewer when you have got the chance to buy the best global one. I have felt blessed to have this global mandate that has helped to generate reasonably good returns on my investors’ capital. I have been privileged not to have money that has been limited by my geography, and I think we have been better off for it because global investing requires that you have a non-provincial perspective.
I would say those are some of the interesting story observations about what it is like in the life of global value investing.
7. I have seen you mention the characteristic of the capacity to suffer. Can you describe the “Capacity to suffer concept"?
Tom Russo: The concept of the capacity to suffer actually ironically came out of Columbia Business School and over the past couple of years. And one of them, Jean-Marie Eveillard, was asked the question. That is precisely what Eveillard looks for when hiring someone. When asked what the most desired quality was in a person to be hired, Eveillard said it was the capacity to suffer. And that is really an incredibly powerful theme.
I thought that was quite amusing because I am saying to you that one of the things that I look for in my managements is for them to have the capacity to suffer. And this is really, an incredibly powerful theme.
I think I have become more attuned to really watching the work of Warren Buffett over the years. When using the term “the capacity to suffer, Eveillard did not mean people had to suffer. Instead, Eveillard meant in order to succeed, people had to feel pain.
8. What are some assumptions that investors might have that make them apprehensive of foreign investing?
Tom Russo: When I started out and talk to investors about investing in foreign stocks, the questions that typically came back at the outset were two. First, “How can you trust the accounting of the non-US companies?” At the very start, my response to that question was “Compared to what?” because it was not clear to me that the US accounting was the only standard in the world. We have certainly proven that over the years by these horrific examples of some of the worst accounting errors and misconduct having been largely American over the past 20 years.
The second question I was inevitably asked for me, was, “How can you trust the currency?” Again, as early as the 1980s, my answer was “Compared to what?” My feeling was that the US dollar was not necessarily the gold standards in terms of currency, because our government was all to prone to promise services that they do not have the capacity to pay for and overtime that is a very dangerous combination. Therefore, I was very comfortable as an American-based investor early on having the capacity to deploy our funds in a way that would benefit from growing profit streams from the parts of the world that I think would have overtime growing currency values anyhow.
The accounting concerns of US investors had at the time only made it more of an undervalued market because you had the largest pool of capital in the world, in the North American Market, which was not being invested in other parts of the world because of these fears. That was a pretty foolhardy step and you had the American public that would not invest abroad because they did not want to take on a currency risk, and they failed to recognize enormous risks that they were taking by holding their own currency exclusive.
Those were the earliest questions people would ask me about global investing. I think (these?) answers have been supported by ensuing investment results, they are delivered over time because the markets for international companies have just been misplaced to begin with, in addition our foreign company managements have shown a standard capacity to grow them dollar bills more than their domestic counterparts. I think we have shown this capacity to grow their dollar bills over the ensuing years. We have harnessed that style which comes from the reinvestment benefits of having owner-minded managements, which I think have more often been found abroad and can still be found if one looks hard enough.
9. Can you cite examples where the “capacity to suffer” concept was demonstrated in Berkshire Hathaway, one of your largest holdings?
Tom Russo: I think we actually have the same capacity to suffer and Berkshire gives three examples of that.
The first is their GEICO example. When Warren Buffett bought GEICO, the company had something like two million policyholders, and Berkshire’s belief was that they were the best insurer in the country. So why should they have a bigger than two percent market share? And the answer was that every new policy that they put on the books reported losses to the firm of $250 of operating losses: reported losses at least when they would sign up for those new policies.
And of course at the same time because of high persistency and because of the great business model of Geico the net present value of each new insured was 1500. So when it was a separately run public company, GEICO was constrained by not being able to take the steps to grow the business optimally because they had to report a $250 loss for every new insured and they kind of measured their growth in the modest pace.
Once it came inside of Berkshire, Warren who doesn’t really care about reporting profits, he was delighted to take steps that could increase the firm’s net present value by adding new policy holders even if it meant that in the year of acquisition, he showed more losses. And you have seen as anybody who has inhabited the earth over the past two decades would have seen this extraordinary life of lizards and cavemen and other forms of spokespeople for Berkshire’s GEICO division and they cost a lot of money. His advertising budget went from $30 million to $950 million over those years.
And yet the number of insurers went from two million to 10 and with $1500 NPV for every new insured customer the value was around $15 billion. Berkshire did that in part because they were permitted to suffer the report the losses of the first year of and celebrate the NPV gains that they picked up. That is one example how Berkshire showed the value of this approach.
The second example had to do with Warren Buffett holding 55 billion in cash earning 0.2% and lamenting about the low returns, and disciplined as he was, he could not have shown $2 billion more in profits on those $50 billion and. He stuck with his guns and so results of that when 2008 – 2009 came along, he was able to extend credit at 10% percent to GE and Goldman Sachs and, it was an extraordinarily rewarding time. He got there because he had the capacity to suffer during those years when he was earning only 0.2 percent and that capacity was very rewarding for us.
What is intriguing is that during that time mainstream American companies were doing just the opposite as Warren. By the time 2009 rolled around, GE may have had I think a hundred billion of its liabilities in overnight money/commercial paper and because of the collapse of Lehman, it was entirely “un-refinanceable”. When GE received capital from Berkshire, GE was able to break the dam and have other people, lend the money as well.
GE took such enormous risk by over-saving the short term profits by not having to pay the market rate on prudent borrowings, which would have been closer to four percent if they were borrowing $100 billion. They were showing a reported interest charge of, half a percent instead in the overnight money. That is another example where the capacity to suffer through lower than possible reported profits, empowered Buffett to get a nice return from a company like GE, which was doing the exact opposite of Buffett.
The clear third example from Berkshire of where those capacities to suffer involved the equity index put options that he wrote over the course of the last couple of years at a time. When, you know, the buyer of that protection needed secure protection against declining asset values. I do not think Berkshire has many competitors when they quoted a $5.3 billion premium because almost no one else had the capital sufficient to assure that they would be able to make good on a $37 billion insurance policy if the world equity markets went to zero. Berkshire has the capital to do that.
They have the mindset that was prepared to let their income statement be burdened by the mark-market risk. In the meantime Buffett had $5 billion plus which they have been able to put to work in high rates and will stay working for us until 2018 or whenever the equity index put options are due.
No collateral posting requirements, which is a lesson that AIG forgot to pay attention to and ultimately, other than the window dressing that takes place on a periodic basis, probably little long term risk that the, since Berkshire will be able to pay out because the duration was so long. In the meantime, at one point, over the last six months, Berkshire had $12 billion reported profit loss on that investment, which meant very little other than it was available to us and not others because most other firms would never risk that kind of reported profit losses that the managements would have to then suffer through. But Buffett had the capacity to suffer through those and I think we’ve profited deeply from it.
10. The WSJ had an article recently which profiled Nestle’s increasing cost of raw materials. Nestle’s management stated that they would not be able to compensate for the increase in costs by an equal increase in prices. Nestle is one of your largest holdings, what are your thoughts?
Tom Russo: Right now, we have – I have 70 percent of my client’s money invested in Western European companies. When you are looking to see if there is value, you are evaluating whether or not you are paying 50 cents on that. Additionally, you are really looking at your ability to redeploy capital at high rates of return because there is the engine for future returns. Nestle for example this past year has taken their spending in emerging markets up from a billion dollars here to two and a half billion. They are three or four billion people in that part of the world, and there is almost no company that is better situated. I cannot think of another than maybe Coca-Cola but it trades for a higher multiple than Nestle.
But for Nestle to have the capacity to direct the adequate amount of money to put themselves in a position to meet their consumer delight and expectation the moment that they can afford Nestle’s products, Nestle is going to be serving as they do already single bouillon cubes of Maggi to Nigerians or to other parts of the world in ever increasing numbers based on the affordability. That’s all those people can afford today, and the reason they cannot afford more of them is that Nestle is going to make darn sure that when they price those bouillon cubes, they price in the cost of commodities.
That is the power of their brands; they are going to take their brands and they are going to innovate and listen to the consumer and come up with bona fide consumer offerings that they value and then since they are valued offerings, they are going to charge for them.
If a company has weak brands and they compete in only domestic markets that are declining and they are facing significant competitors, it is not the kind of environment which you would think has the capacity to reward future investments. However, that is not the world that Nestle faces. They have their branded products which gives them that measure of trust. They innovated around those brands so that the consumer does not face the competitive offering. Nestle is willing to invest even in countries with enormous risk, which means that they have been able to take a toehold in China and in Russia, in other markets which is putting them permanently in front of the consumer in a preferred way, locking out the possibility of new competitors. I think Nestle is a usually strong example of this phenomenon.
In the 1999 period where there was a horrific currency crisis involving the Russian ruble and all the consequences around the world, Nestle had the good sense to stay the course in Russia and during the downturn that followed the ruble crisis, they invested in manufacturing, and in distribution. They acquired businesses. They invested in their brands. They lost a lot of money during the aftermath of the ruble crisis because very few people could afford to buy the products, but as a result they have built in the face of that downturn a franchise that today is really indomitable in Russia.
They took the same kind of patient approach in China where they had start-up losses, but they stayed the course and it is that willingness to invest even at the expense of reported profits like they did in those downturns.
The thought that somebody would not buy Nestle today because barley costs or coco costs or coffee beans are expensive today or that polyethylene or energy costs are expensive today, these are businesses that have been able to stay with the consumer for a hundred years that are today in a more privileged position competitively because they have products that the emerging markets demand and covet. And they have a capital to employ in the emerging markets in a way that will help them grow that powerful franchise. I think we are quite lucky that the world views Nestle different than we do, because that means I can buy more shares of Nestle at fairer prices due to the fact that others are concerned over something that I believe to be very transitory, which is, the commodity costs.
In terms of commodity costs, they can modify. They can re-specify the manufacturing counts. They can substitute products. There are so many ways that they can over time preserve their business in the face of commodity costs and mind you, since they are the largest in most of the businesses they compete in, commodity costs are actually going to be more damaging to the smaller companies that don’t have the skill that Nestle has because those companies are already more cost-burdened.
And then the last point is people I think mistake one aspect of the rise in commodity cost of; to me it only serves as confirmation of the strength of Nestle’s franchise, which they now can find in commodity cost inflation, because it is that same consumer in China whose incremental demand weighs upon the global supply of grain and protein, that drives the grain and protein demand. But the very existence of that consumer’s insatiable demand is expressed in commodity cost.
In some ways when someone says, that there is global deflation because the consumer in China is pulling back, they have no more money to spend and the incremental demand of those scarce resources is going down because the emerging market economies are desolate, I would take that as more of a concern than people saying, “What are you going to do with global leading companies that you own in light of the fact that the increasing demand coming from rising prosperity against the world’s scarce resources are driving inflation higher?” That does not seem like such a bad problem to me if you maintain a long term perspective.
If you worry only on a short term basis, then you might be inclined to sell Nestlé today because two quarters from now, the forecasted earnings per share will be difficult to meet because you will have a view that energy or cocoa prices are going to be different from what the company forecasted.
That is a game and it is very difficult to play, and it means that you are likely going to be on the sidelines when real value is being created and the market’s collective desire to move away from these concerns go away and company’s share price is attractively valued.
Nestle is my largest holding. It is good that you asked the question in commodities relative to Nestle because I think, they have the capacity to absorb those costs through their strong brands and it’s really dumb, to sell Nestle because of commodity costs and then not to consider the benefit from them, when having a long-term minded careful stewards of your capital deploy three times as much money as they have been for instance in developing emerging markets, because they can’t meet the demands of the products that their early steps generated. It seems that this problem is short term. The reason they enjoy the benefits that they do is because they have an unusually complete and competitive management team, an extraordinary management team, an extraordinary management culture that looks beyond the quarters in a. And it’s available at a cheap multiple of something like 13 times net income.
If you have long term-minded investors, who allow their money manager the capacity to suffer, and you think out long term, you probably can absorb the risk that commodities will cost Nestlé at some point, an embarrassing quarter and, but the unwillingness on the part of the markets generally is I think what makes this portfolio of those international consumer brand with those companies still attractively-priced.
It is pretty hard to see why you would want to give up such an offer simply because grain costs are going to be higher than people thought two quarters from now.
11. What are your thoughts on currency risk and hedging, especially in the Euro-zone where you invest a good portion of your money?
Tom Russo: People really fear with Nestle and other holdings in the euro zone about a collapse of the euro. I think they worry unnecessarily about the potential collapse of the euro and what they missed in that analysis is that Nestle is growing streams of its European process and investing them in emerging market businesses and those emerging market businesses over time will draw back to Nestle, increasing constant currency profits because of volume growth, pricing and cost benefits as they have scale advantages over time.
Therefore, local currency pricing does not concern me, but on top of that, I think over time if the euro weakens and some people fear it will, those streams will come back in ever more euros and so we’re a bit hedged against a decline of the euro because, the fact that 55 plus percent of Unilever’s profit come from developing emerging markets, and over 30% of Nestle’s profits come from emerging markets and that number will increase to over 50% in the next 15 years.
We have a growing exposure to profit exchange from non-euro parts of the world and we are redeploying our euro land profits and cash into the development of the parts of the world where the population grows, the disposable income grows. The currencies will likely strengthen because of increased economic relevance of the economies.
So it is a long-winded answer but this is a pretty interesting investment, even if as the Wall Street Journal suggested today it may be prudent for some investors to take money off of Nestlé’s positions in light of the fact that there will be some surprising negative quarters in the short term.
That is a game others can pay profitably, but I just look for a great business with a strong global reinvestment engine at its fingertips with powerful brands of support the spending of hold this for a long time. I’ve owned Nestlé since 1987 after all.
It has compounded almost 15 percent a year total returns since 1987 and I think it may be more attractively-positioned today than it was then. And over that time, we have had a whole bunch of periods of time when commodity costs went up a lot and Nestle has been able to nonetheless, you know, go with their business around such volatility.
12. What makes the strongest consumer brand?
Tom Russo: Pricing power is the expression of a brand if you have got it. Take premium spirits for example. You have the capacity but you have to be careful of how you exercise this because it is a hit or miss exercise periodically but you have the capacity to have a $90 bottle of Johnny Walker Scotch Whisky, a $70 bottle, a $50 bottle, a $40 bottle, a $20 bottle, and that price proposition allows you to have a far higher premium price for Scotch whisky as you go up the brand’s proposition, which fills the consumer’s needs state than for the starting offer.
In the beer industry, SABMiller have spent the years talking about consumer needs state, and the pricing premium that they have for their international premium of brands. It might be as much as five times the price of the entry level price proposition in some markets. But the brand stands for an offering that the consumer at some point does not feel that they can get where else, and if they are willing to pay for it
, it is not because the cost of grain and barley has gone up. It is because they believe that they will not be let down by the brand and that is, , a very psychological way that the brand will the consumer who’s loyal to that brand, to protect the kind of stature and standing that you believe you are entitled to either now or that someday soon. I mean that was a great commercial for Heineken back in the 70s. When they say someday soon the best will come, you know well that is not going to happen for a while but until then, drink Heineken. The people who had the judgment to position themselves to drink Heineken were those same people who were eventually telling their consumers that, pretty soon they are going to have everything they need. But in the meantime, Heineken just served their needs and that brand positioning is very valuable.
That is at the high end. What is the difference in fact between Coca-Cola and the Cott’s cola soft drink, you know, in terms of taste profile. Probably it’s very, very little. But that private label soft drink never really did catch hold because of the brand that Coke stands for. It is much more than just caramel and caffeine and carbonation and that essence that Coke added in some stuff that is more than just the ingredients. It is what you get paid for in life and that is why brands are so valuable. That is why you spend so much to try to create them and why if you have them, you’re advised to spend so much to sustain them.
We live in a world of growing investor concerns over premium and price value by the label. I know many investors who have shifted their allegiance from the brand goods manufacturers which is where I am stuck owning this year, I guess, rather than stay stuck that’s where I continue to find the value is under the manufacturers of the premium brands.
My belief is that the premium brand manufacturers will gain insight through focus groups, which will lead them to early, early innovations that they can not only get enough price for, but also reward the customer and help them maintain big margins. Additionally I believe they will also be able enough to advertise to the consumer to make them comfortable with their decision, and to have enough left over for us the owners to have an attractive return on our capital.
I believe that that model is not broken. There are others who would allege that it is, and that Costco and Wal-mart are creating a third element between the consumer and the brands, that being private label and there’s nervousness about that. That is what allows us to buy our global consumer goods at a reasonable price. We not only have the fear over the commodity pressures. We have a fear for the euro. We have a fear for private label. I think all three of those are addressable by well-managed companies such as Nestle, Pernod Ricard, Unilever, Heineken and Philip Morris.
14. You were bullish on Citi and AIG in 2006 because of strong brands, but then you got out before the whole crash. I saw in an interview in early 2008 that you stated that you did not understand the CDOs, which Citi was holding. Congratulations you are one of the many few investors who got out in time!
Tom Russo: It was the SIVs. I could not understand it, which was in effect part of the compensation system. They you would underwrite bonds that you get paid for, but there were no natural buyers so they would be sent over to Citigroup and they would be stuck off the balance sheet in a structured investment vehicle. The professionals who underwrote the bonds received high compensation based on their production but the bonds were not sold and they really were hard to understand. When I heard that device was rapidly being deployed, I figured that it was late in the game and I had no interest of such shenanigans.
I came out of Citi at attractive price early on before the whole blow up. The reason why both of those were in the portfolio in the first place was because I felt that each of them was preeminent in the emerging and developing markets. Citibank was this Japanese business and its early business in Asia, and Shanghai being the original headquarters of AIG.
You could not find company with more international emerging markets exposure than AIG. I also found it intriguing the fact that both companies had strong inside ownership; Sandy Weill of Citi and Hank Greenberg of AIG. I think Hank Greenberg controlled $20 billion worth of AIG shares in the start and I thought, they had very global franchisers. They both had very serious inside ownerships; which created the alignment of interest with shareholders. In each case however both AIG through Spitzer’s fiat and Citigroup through Weill’s own evolution were increasingly run in a manner disconnected from those significant shareholders and early leaders.
And I overlooked that. I missed that, the significance of those measures, because I thought the cultures would have had more of a muscle memory, and that the businesses would continue to be well run. But absent those interested owners reigning over their troops, it is extraordinary how quickly you ended up with something like the financial products division in England, exposing AIG to the very core of its survival through mispriced and the collateral burden of the insurance policies for no premium.
I figured that out late in the chase, and sold them at a much higher price , but did not shower myself the glory from that investment and in part because I probably was, you know, so enamored by even the weakening, growing reports of their exposure from the emerging markets.
I kept overweighing those in hindsight and under-weighing the grumblings of rumors that they were taking up liabilities that I could not get access to. I asked the chairman, CFO and the CEO and they suggest that all those exposures would ultimately prove profitable, and assured us that the accountants required too big of a mark-market discount. The management assured us that they would not in fact be so severe upon maturity and they just had to wait until the maturity. And of course it was a complete nonsense and the appeal of the international insurance world for AIG, was completely misguiding, because the risks that they were taking on were so enormous.
15. What do you think of the companies now?
Tom Russo: Their global franchise has been shrunken sharply. They sold off lots of pieces of their franchise to try to get off the hook from the government. The government protection has given them a checkbook that has allowed them to be very disruptive over the past say three years. General accounting, general terms of the industry as those with whom they compete suggest that they have competed with the benefit of the shorter term capital then they would have had without Government support, and therefore undermine the naturally higher premium that would have surfaced in the market in light of the massive hemorrhaging that represented AIG.
It never surfaced in the market because the government backs up that risk and so AIG then was free to continue to operate in a way that did not probably bear the full cost of the riskiness. And to this day, I do not have an opinion about the general business because so much business separated from the parent through sales.
I know there are some very, very, very smart investors who have made extraordinarily large investments in the company and I respect them and watch with interest how that might unfold.
But for the time being, I remain squarely on the sidelines and to the place that’s on the field on that particular case. I am on the playing fields as it relates to the growth in the emerging market consumer having a loyalty to brands or the capacity increasing to pay for them because they are aspirational and they can have great affordability. And the proposition that our leading participants in those regions have managements who have the capacity to suffer through the early burdens to report the profits that come from proper investment in those markets despite the impact that appears on the income statement.
If these companies continue to nourish their brands heavily to meet future demand, we should be able to foreclose future entrance, and to enjoy a very healthy return from those parts of the world that I think over time will have growing currency values and so there is a benefit for an American investor. The payback on investments should be well made, and potential benefit that comes from protection against growth and currency that is abroad.
Note: Additional interview with Tom Russo can be read on this edition of Graham and Doddsville (
Graham & Doddsville - Issue 15 - Spring 2012.pdf (Size: 3.99 MB / Downloads: 6)
). It also contains interview with Julian Robertson and Jim Chanos
By Jacob Wolinsky, October 24, 2011
Thomas Russo overseas over $6 billion as a general partner of Semper Vic Partners and Semper Vic Partners(Q.P) limited partnership along with overseeing in discretionary individually managed accounts for individuals, trusts and endowments. Russo graduated from Dartmouth College (BA, 1977) and Stanford Business and Law Schools (MBA/JD, 1984).
Russo’s Semper Vic Partners fund has returned a cumulative 2,754.9 % versus 979.9 % for the S&P 500.
1. Can you briefly describe the concept of global value investing and who influenced you?
Tom Russo: I have several billion dollars under management, which I invest in global equities. It was for the longest time a style that was not practiced by anyone. It was global, not local or international, so that was already confusing to most consultants. And then there was a long-term focus with taxable investors in an effort to abide by Warren Buffett’s advice to invest long term and then harvest the profits from that over a lifetime. This is a very unusual aspect of what we do and it is mainly unusual because most people cannot abide by doing nothing for long periods of time. Most people find the working environment leads them to do something, so they are much more active than the necessarily need to be.
So I would say global and unusual. It is less so now, though. There are more people in this world of global investment. We see the incredible rise in relevance of non-US investments because of the relative growth in GDPs around the world. I was drawn into this style in the early 1980s. The concept of international came to me through Stanford Business School when Professor McDonald, who taught my investment class, said “Do not be provincial.” Ninety-Five percent of the world does not live in the United States. Figure out a way to make investments that recognize the promise of that 95 % of the world. That happens all the time. The US market was far bigger than any of the other markets, and we had a higher GDP than relative to the world now, but over time the advice to go abroad early in my career has made all the difference in my career.
2. What is your approach to value investing?
Think about the goal of investing, which stems from the value approach of Warren Buffet. That is to find 50-cent dollar bills. That is an okay approach. It is hard enough to do, but it is an okay approach if you find 50-cent dollar bills and you are indifferent to taxation and you can somehow close out that discount quickly.
I think you do not really care about the dollar bill very much if you are like me, since as a long-term investor what you really want to do is find a 50-cent dollar bill that will grow over the years. And it is that growth component that provides the returns. We have been fortunate to harness the power of such growth through our international franchise. Buying dollar bills at 50 cents provides a measure of safety. Finding strong companies whose owner (mimics?) management, and is capable of investing to grow that dollar bill (underwritten?) for future returns.
3. What do you define as a powerful brand? Is it a moat?
Tom Russo: Nestle is our largest position, followed shortly by Phillip Morris International. We also own Richemont, which is a Swiss Company that has global brands such as Cartier and Dunhill; Heineken, which we first invested in 1989; followed by SABMiller, which I added to my portfolios in 2009; followed by Pernod Ricard, which I invested in probably 2003.
All of these businesses have powerful goodwill associated with their global brands. And it is the ability that they have enjoyed over the past 25 years to increasingly exploit that goodwill in growing parts of the world because of the rise of consumerism and the rise of open markets that has given our portfolio a really strong tail wind.
Additionally, it is the fact that the management of those companies is very often guided by the wishes of their founding families and owners that have made the investment decision. I think by those managements, better in terms of guidance and advice from owners than the traditional American Company has, where so often management reigns without constraint by any kind of owner-mindedness.
And so we have had the privilege of global brands to invest behind by managements who are encouraged to make thoughtful owner-minded investments by the fact that the company’s founding families are still involved in my portfolio to a most unusual extent.
When management makes those investments, they must have the capacity to suffer. They have to suffer during the start-up period of those investments because they are not necessarily linked to at the hip with the Wall Street expectations of smooth and steady quarters, but they are able to withstand the burden of the investment cycle. It is inevitably certain that profits are low or non-existent during these early years. And if you do not have the capacity to suffer through that period, you will shy away from making the accurate amount of investment. Your management will under-invest at a time when they have set an advantage and will allow competitors to come into the market.
I think having family-owned businesses at the helm of our companies in many instances has stretched out our management’s horizon. It has given more courage to invest even when the reputed earnings of our company may be temporarily burdened by start-up losses from these investments.
4. Do you think going international has given you a strong lead against other investors?
Tom Russo: I think that going international has given us an enormous leg up because we have increased the number of brands that we get behind, we increased the management focus on owner-mindedness and we increased the capacity for them to invest. I can give you a bunch of examples of how I think our portfolio companies are better today because during periods of time when there is competition, they do not shy away from making investments because of their burdens on income statements. Our companies stay the course, suffered through those early burdens and effects on their income statements or report of profits. And then our companies have enjoyed the wealth that has grown from that capacity to suffer.
As an international (investor in?) brands, for managements have been well positioned for markets that have opened up over the past three decades. I have exposed us and our business to substantial population growth in the developing and emerging markets in the developing and emerging markets and also new populations if you think about places like India and China, which were closed to our companies just two decades ago. They now represent nearly three billion consumers to which we actually market products.
5. Can you give examples of the pricing powers of these companies?
Tom Russo: I think our businesses have shown over time that they have pricing power which is because of the strength of the brand. That is extremely important long term because it is that pricing power that accompanies a product’s perceived indispensability in the minds of the consumer that allows our business to raise prices in sufficient amounts to offset the pressure of commodities and inflation.
And a good example of this occurred when I was once on a plane. I had a colleague sitting next to me in an airplane who ordered a Jack Daniel’s and the steward came back and said “I am sorry. We only have Jim Beam,” to which he said, “No thanks, I would rather have water.”It is that kind of consumer loyalty that means that the brands have power—if the steward came back and said “Yes, you can have Jack for a dollar more than Jim Beam” he probably would have paid. We want to make sure we have businesses that have that pricing power.
I think by and large we just found that and the pricing power is particularly important in the developing, emerging markets because they enjoy rising consumer disposable income. Nestle and Unilever, which are two large holdings, understand that they have to go into the markets early on with popularly-priced products that are either a different variation of their Western market products or are simply sold in different packet sizes.
By using the popularly-priced product, they are able to have the price that the consumer can afford at the start and as that consumer has more disposable income, they can introduce multipacks, which increase the consumption or they can introduce more of a premium package to products which drive the aspirational consumer forward.
6. Is it important for consumers to adopt a global perspective?
I think by having an early introduction to the non-US markets as early as 1982 and by my business school professor to not be provincial, that I have gained an edge. I have had—through that global outlet, enormous opportunity. And the thing is, if you adopt a global perspective, I think in terms of population growth, pricing power, and volume growth and all of those things. But it also allows an investor who is focused on a handful of industries like myself; mainly the food, beverage, tobacco and media to stay focused. It allowed me to keep my capital more employed during those periods of time when industries such as the ones I have mentioned became overvalued in their home market. So in 1986, for example, When KKR took over RJR Nabisco, and most food and beverage companies have pretty high-sized valuation because of the belief that the next leveraged buyout would come along and increase the values, I found better values abroad.
At that time, I was able to make continuing terrific investments in Heineken and a breakfast cereal company based in England in 1986 and 1987. I was able to purchase shares in both at single digit multiples, whereas in the US, because of RJR and the takeover fever that ensued in the mid-1980s, the multiples were often twice as high in the US.
Having the outlet to deploy your capital in that handful of businesses by keeping a global perspective meant that I did not have to go to find other places to invest other than the businesses that I admire just because companies’ share prices had gone up to an inflated level as a result of the takeover activity.
Lastly, you know, if you ever sort of wonder global is the hunt for value of—the other thing that has happened is that at least in the industries I participate in, it is almost impossible to think about conducting fundamental research on consumer product industries without having a global perspective.
When I started in the 1980s, the three Japanese brewers were the largest in the world, and over time the Anheuser-Busch became slightly larger than them, but you cannot have a view on global beer if you are forced as an investor to only focus on the US beer companies.
In the areas that I tend to find of interest (food, beverage, beer, spirits, tobacco, etc) the global aspect is a by-product of the research process as you are forced to consider global competition. There is a competitive step that occurs when you are making investment decisions about relative valuation and if you are going to look back at competitors like Heineken instead of Budweiser. If Heineken has a better business, better brand, more disciplined investment process than Budweiser—you should certainly not limit your portfolio to just the best American brewer when you have got the chance to buy the best global one. I have felt blessed to have this global mandate that has helped to generate reasonably good returns on my investors’ capital. I have been privileged not to have money that has been limited by my geography, and I think we have been better off for it because global investing requires that you have a non-provincial perspective.
I would say those are some of the interesting story observations about what it is like in the life of global value investing.
7. I have seen you mention the characteristic of the capacity to suffer. Can you describe the “Capacity to suffer concept"?
Tom Russo: The concept of the capacity to suffer actually ironically came out of Columbia Business School and over the past couple of years. And one of them, Jean-Marie Eveillard, was asked the question. That is precisely what Eveillard looks for when hiring someone. When asked what the most desired quality was in a person to be hired, Eveillard said it was the capacity to suffer. And that is really an incredibly powerful theme.
I thought that was quite amusing because I am saying to you that one of the things that I look for in my managements is for them to have the capacity to suffer. And this is really, an incredibly powerful theme.
I think I have become more attuned to really watching the work of Warren Buffett over the years. When using the term “the capacity to suffer, Eveillard did not mean people had to suffer. Instead, Eveillard meant in order to succeed, people had to feel pain.
8. What are some assumptions that investors might have that make them apprehensive of foreign investing?
Tom Russo: When I started out and talk to investors about investing in foreign stocks, the questions that typically came back at the outset were two. First, “How can you trust the accounting of the non-US companies?” At the very start, my response to that question was “Compared to what?” because it was not clear to me that the US accounting was the only standard in the world. We have certainly proven that over the years by these horrific examples of some of the worst accounting errors and misconduct having been largely American over the past 20 years.
The second question I was inevitably asked for me, was, “How can you trust the currency?” Again, as early as the 1980s, my answer was “Compared to what?” My feeling was that the US dollar was not necessarily the gold standards in terms of currency, because our government was all to prone to promise services that they do not have the capacity to pay for and overtime that is a very dangerous combination. Therefore, I was very comfortable as an American-based investor early on having the capacity to deploy our funds in a way that would benefit from growing profit streams from the parts of the world that I think would have overtime growing currency values anyhow.
The accounting concerns of US investors had at the time only made it more of an undervalued market because you had the largest pool of capital in the world, in the North American Market, which was not being invested in other parts of the world because of these fears. That was a pretty foolhardy step and you had the American public that would not invest abroad because they did not want to take on a currency risk, and they failed to recognize enormous risks that they were taking by holding their own currency exclusive.
Those were the earliest questions people would ask me about global investing. I think (these?) answers have been supported by ensuing investment results, they are delivered over time because the markets for international companies have just been misplaced to begin with, in addition our foreign company managements have shown a standard capacity to grow them dollar bills more than their domestic counterparts. I think we have shown this capacity to grow their dollar bills over the ensuing years. We have harnessed that style which comes from the reinvestment benefits of having owner-minded managements, which I think have more often been found abroad and can still be found if one looks hard enough.
9. Can you cite examples where the “capacity to suffer” concept was demonstrated in Berkshire Hathaway, one of your largest holdings?
Tom Russo: I think we actually have the same capacity to suffer and Berkshire gives three examples of that.
The first is their GEICO example. When Warren Buffett bought GEICO, the company had something like two million policyholders, and Berkshire’s belief was that they were the best insurer in the country. So why should they have a bigger than two percent market share? And the answer was that every new policy that they put on the books reported losses to the firm of $250 of operating losses: reported losses at least when they would sign up for those new policies.
And of course at the same time because of high persistency and because of the great business model of Geico the net present value of each new insured was 1500. So when it was a separately run public company, GEICO was constrained by not being able to take the steps to grow the business optimally because they had to report a $250 loss for every new insured and they kind of measured their growth in the modest pace.
Once it came inside of Berkshire, Warren who doesn’t really care about reporting profits, he was delighted to take steps that could increase the firm’s net present value by adding new policy holders even if it meant that in the year of acquisition, he showed more losses. And you have seen as anybody who has inhabited the earth over the past two decades would have seen this extraordinary life of lizards and cavemen and other forms of spokespeople for Berkshire’s GEICO division and they cost a lot of money. His advertising budget went from $30 million to $950 million over those years.
And yet the number of insurers went from two million to 10 and with $1500 NPV for every new insured customer the value was around $15 billion. Berkshire did that in part because they were permitted to suffer the report the losses of the first year of and celebrate the NPV gains that they picked up. That is one example how Berkshire showed the value of this approach.
The second example had to do with Warren Buffett holding 55 billion in cash earning 0.2% and lamenting about the low returns, and disciplined as he was, he could not have shown $2 billion more in profits on those $50 billion and. He stuck with his guns and so results of that when 2008 – 2009 came along, he was able to extend credit at 10% percent to GE and Goldman Sachs and, it was an extraordinarily rewarding time. He got there because he had the capacity to suffer during those years when he was earning only 0.2 percent and that capacity was very rewarding for us.
What is intriguing is that during that time mainstream American companies were doing just the opposite as Warren. By the time 2009 rolled around, GE may have had I think a hundred billion of its liabilities in overnight money/commercial paper and because of the collapse of Lehman, it was entirely “un-refinanceable”. When GE received capital from Berkshire, GE was able to break the dam and have other people, lend the money as well.
GE took such enormous risk by over-saving the short term profits by not having to pay the market rate on prudent borrowings, which would have been closer to four percent if they were borrowing $100 billion. They were showing a reported interest charge of, half a percent instead in the overnight money. That is another example where the capacity to suffer through lower than possible reported profits, empowered Buffett to get a nice return from a company like GE, which was doing the exact opposite of Buffett.
The clear third example from Berkshire of where those capacities to suffer involved the equity index put options that he wrote over the course of the last couple of years at a time. When, you know, the buyer of that protection needed secure protection against declining asset values. I do not think Berkshire has many competitors when they quoted a $5.3 billion premium because almost no one else had the capital sufficient to assure that they would be able to make good on a $37 billion insurance policy if the world equity markets went to zero. Berkshire has the capital to do that.
They have the mindset that was prepared to let their income statement be burdened by the mark-market risk. In the meantime Buffett had $5 billion plus which they have been able to put to work in high rates and will stay working for us until 2018 or whenever the equity index put options are due.
No collateral posting requirements, which is a lesson that AIG forgot to pay attention to and ultimately, other than the window dressing that takes place on a periodic basis, probably little long term risk that the, since Berkshire will be able to pay out because the duration was so long. In the meantime, at one point, over the last six months, Berkshire had $12 billion reported profit loss on that investment, which meant very little other than it was available to us and not others because most other firms would never risk that kind of reported profit losses that the managements would have to then suffer through. But Buffett had the capacity to suffer through those and I think we’ve profited deeply from it.
10. The WSJ had an article recently which profiled Nestle’s increasing cost of raw materials. Nestle’s management stated that they would not be able to compensate for the increase in costs by an equal increase in prices. Nestle is one of your largest holdings, what are your thoughts?
Tom Russo: Right now, we have – I have 70 percent of my client’s money invested in Western European companies. When you are looking to see if there is value, you are evaluating whether or not you are paying 50 cents on that. Additionally, you are really looking at your ability to redeploy capital at high rates of return because there is the engine for future returns. Nestle for example this past year has taken their spending in emerging markets up from a billion dollars here to two and a half billion. They are three or four billion people in that part of the world, and there is almost no company that is better situated. I cannot think of another than maybe Coca-Cola but it trades for a higher multiple than Nestle.
But for Nestle to have the capacity to direct the adequate amount of money to put themselves in a position to meet their consumer delight and expectation the moment that they can afford Nestle’s products, Nestle is going to be serving as they do already single bouillon cubes of Maggi to Nigerians or to other parts of the world in ever increasing numbers based on the affordability. That’s all those people can afford today, and the reason they cannot afford more of them is that Nestle is going to make darn sure that when they price those bouillon cubes, they price in the cost of commodities.
That is the power of their brands; they are going to take their brands and they are going to innovate and listen to the consumer and come up with bona fide consumer offerings that they value and then since they are valued offerings, they are going to charge for them.
If a company has weak brands and they compete in only domestic markets that are declining and they are facing significant competitors, it is not the kind of environment which you would think has the capacity to reward future investments. However, that is not the world that Nestle faces. They have their branded products which gives them that measure of trust. They innovated around those brands so that the consumer does not face the competitive offering. Nestle is willing to invest even in countries with enormous risk, which means that they have been able to take a toehold in China and in Russia, in other markets which is putting them permanently in front of the consumer in a preferred way, locking out the possibility of new competitors. I think Nestle is a usually strong example of this phenomenon.
In the 1999 period where there was a horrific currency crisis involving the Russian ruble and all the consequences around the world, Nestle had the good sense to stay the course in Russia and during the downturn that followed the ruble crisis, they invested in manufacturing, and in distribution. They acquired businesses. They invested in their brands. They lost a lot of money during the aftermath of the ruble crisis because very few people could afford to buy the products, but as a result they have built in the face of that downturn a franchise that today is really indomitable in Russia.
They took the same kind of patient approach in China where they had start-up losses, but they stayed the course and it is that willingness to invest even at the expense of reported profits like they did in those downturns.
The thought that somebody would not buy Nestle today because barley costs or coco costs or coffee beans are expensive today or that polyethylene or energy costs are expensive today, these are businesses that have been able to stay with the consumer for a hundred years that are today in a more privileged position competitively because they have products that the emerging markets demand and covet. And they have a capital to employ in the emerging markets in a way that will help them grow that powerful franchise. I think we are quite lucky that the world views Nestle different than we do, because that means I can buy more shares of Nestle at fairer prices due to the fact that others are concerned over something that I believe to be very transitory, which is, the commodity costs.
In terms of commodity costs, they can modify. They can re-specify the manufacturing counts. They can substitute products. There are so many ways that they can over time preserve their business in the face of commodity costs and mind you, since they are the largest in most of the businesses they compete in, commodity costs are actually going to be more damaging to the smaller companies that don’t have the skill that Nestle has because those companies are already more cost-burdened.
And then the last point is people I think mistake one aspect of the rise in commodity cost of; to me it only serves as confirmation of the strength of Nestle’s franchise, which they now can find in commodity cost inflation, because it is that same consumer in China whose incremental demand weighs upon the global supply of grain and protein, that drives the grain and protein demand. But the very existence of that consumer’s insatiable demand is expressed in commodity cost.
In some ways when someone says, that there is global deflation because the consumer in China is pulling back, they have no more money to spend and the incremental demand of those scarce resources is going down because the emerging market economies are desolate, I would take that as more of a concern than people saying, “What are you going to do with global leading companies that you own in light of the fact that the increasing demand coming from rising prosperity against the world’s scarce resources are driving inflation higher?” That does not seem like such a bad problem to me if you maintain a long term perspective.
If you worry only on a short term basis, then you might be inclined to sell Nestlé today because two quarters from now, the forecasted earnings per share will be difficult to meet because you will have a view that energy or cocoa prices are going to be different from what the company forecasted.
That is a game and it is very difficult to play, and it means that you are likely going to be on the sidelines when real value is being created and the market’s collective desire to move away from these concerns go away and company’s share price is attractively valued.
Nestle is my largest holding. It is good that you asked the question in commodities relative to Nestle because I think, they have the capacity to absorb those costs through their strong brands and it’s really dumb, to sell Nestle because of commodity costs and then not to consider the benefit from them, when having a long-term minded careful stewards of your capital deploy three times as much money as they have been for instance in developing emerging markets, because they can’t meet the demands of the products that their early steps generated. It seems that this problem is short term. The reason they enjoy the benefits that they do is because they have an unusually complete and competitive management team, an extraordinary management team, an extraordinary management culture that looks beyond the quarters in a. And it’s available at a cheap multiple of something like 13 times net income.
If you have long term-minded investors, who allow their money manager the capacity to suffer, and you think out long term, you probably can absorb the risk that commodities will cost Nestlé at some point, an embarrassing quarter and, but the unwillingness on the part of the markets generally is I think what makes this portfolio of those international consumer brand with those companies still attractively-priced.
It is pretty hard to see why you would want to give up such an offer simply because grain costs are going to be higher than people thought two quarters from now.
11. What are your thoughts on currency risk and hedging, especially in the Euro-zone where you invest a good portion of your money?
Tom Russo: People really fear with Nestle and other holdings in the euro zone about a collapse of the euro. I think they worry unnecessarily about the potential collapse of the euro and what they missed in that analysis is that Nestle is growing streams of its European process and investing them in emerging market businesses and those emerging market businesses over time will draw back to Nestle, increasing constant currency profits because of volume growth, pricing and cost benefits as they have scale advantages over time.
Therefore, local currency pricing does not concern me, but on top of that, I think over time if the euro weakens and some people fear it will, those streams will come back in ever more euros and so we’re a bit hedged against a decline of the euro because, the fact that 55 plus percent of Unilever’s profit come from developing emerging markets, and over 30% of Nestle’s profits come from emerging markets and that number will increase to over 50% in the next 15 years.
We have a growing exposure to profit exchange from non-euro parts of the world and we are redeploying our euro land profits and cash into the development of the parts of the world where the population grows, the disposable income grows. The currencies will likely strengthen because of increased economic relevance of the economies.
So it is a long-winded answer but this is a pretty interesting investment, even if as the Wall Street Journal suggested today it may be prudent for some investors to take money off of Nestlé’s positions in light of the fact that there will be some surprising negative quarters in the short term.
That is a game others can pay profitably, but I just look for a great business with a strong global reinvestment engine at its fingertips with powerful brands of support the spending of hold this for a long time. I’ve owned Nestlé since 1987 after all.
It has compounded almost 15 percent a year total returns since 1987 and I think it may be more attractively-positioned today than it was then. And over that time, we have had a whole bunch of periods of time when commodity costs went up a lot and Nestle has been able to nonetheless, you know, go with their business around such volatility.
12. What makes the strongest consumer brand?
Tom Russo: Pricing power is the expression of a brand if you have got it. Take premium spirits for example. You have the capacity but you have to be careful of how you exercise this because it is a hit or miss exercise periodically but you have the capacity to have a $90 bottle of Johnny Walker Scotch Whisky, a $70 bottle, a $50 bottle, a $40 bottle, a $20 bottle, and that price proposition allows you to have a far higher premium price for Scotch whisky as you go up the brand’s proposition, which fills the consumer’s needs state than for the starting offer.
In the beer industry, SABMiller have spent the years talking about consumer needs state, and the pricing premium that they have for their international premium of brands. It might be as much as five times the price of the entry level price proposition in some markets. But the brand stands for an offering that the consumer at some point does not feel that they can get where else, and if they are willing to pay for it
, it is not because the cost of grain and barley has gone up. It is because they believe that they will not be let down by the brand and that is, , a very psychological way that the brand will the consumer who’s loyal to that brand, to protect the kind of stature and standing that you believe you are entitled to either now or that someday soon. I mean that was a great commercial for Heineken back in the 70s. When they say someday soon the best will come, you know well that is not going to happen for a while but until then, drink Heineken. The people who had the judgment to position themselves to drink Heineken were those same people who were eventually telling their consumers that, pretty soon they are going to have everything they need. But in the meantime, Heineken just served their needs and that brand positioning is very valuable.
That is at the high end. What is the difference in fact between Coca-Cola and the Cott’s cola soft drink, you know, in terms of taste profile. Probably it’s very, very little. But that private label soft drink never really did catch hold because of the brand that Coke stands for. It is much more than just caramel and caffeine and carbonation and that essence that Coke added in some stuff that is more than just the ingredients. It is what you get paid for in life and that is why brands are so valuable. That is why you spend so much to try to create them and why if you have them, you’re advised to spend so much to sustain them.
We live in a world of growing investor concerns over premium and price value by the label. I know many investors who have shifted their allegiance from the brand goods manufacturers which is where I am stuck owning this year, I guess, rather than stay stuck that’s where I continue to find the value is under the manufacturers of the premium brands.
My belief is that the premium brand manufacturers will gain insight through focus groups, which will lead them to early, early innovations that they can not only get enough price for, but also reward the customer and help them maintain big margins. Additionally I believe they will also be able enough to advertise to the consumer to make them comfortable with their decision, and to have enough left over for us the owners to have an attractive return on our capital.
I believe that that model is not broken. There are others who would allege that it is, and that Costco and Wal-mart are creating a third element between the consumer and the brands, that being private label and there’s nervousness about that. That is what allows us to buy our global consumer goods at a reasonable price. We not only have the fear over the commodity pressures. We have a fear for the euro. We have a fear for private label. I think all three of those are addressable by well-managed companies such as Nestle, Pernod Ricard, Unilever, Heineken and Philip Morris.
14. You were bullish on Citi and AIG in 2006 because of strong brands, but then you got out before the whole crash. I saw in an interview in early 2008 that you stated that you did not understand the CDOs, which Citi was holding. Congratulations you are one of the many few investors who got out in time!
Tom Russo: It was the SIVs. I could not understand it, which was in effect part of the compensation system. They you would underwrite bonds that you get paid for, but there were no natural buyers so they would be sent over to Citigroup and they would be stuck off the balance sheet in a structured investment vehicle. The professionals who underwrote the bonds received high compensation based on their production but the bonds were not sold and they really were hard to understand. When I heard that device was rapidly being deployed, I figured that it was late in the game and I had no interest of such shenanigans.
I came out of Citi at attractive price early on before the whole blow up. The reason why both of those were in the portfolio in the first place was because I felt that each of them was preeminent in the emerging and developing markets. Citibank was this Japanese business and its early business in Asia, and Shanghai being the original headquarters of AIG.
You could not find company with more international emerging markets exposure than AIG. I also found it intriguing the fact that both companies had strong inside ownership; Sandy Weill of Citi and Hank Greenberg of AIG. I think Hank Greenberg controlled $20 billion worth of AIG shares in the start and I thought, they had very global franchisers. They both had very serious inside ownerships; which created the alignment of interest with shareholders. In each case however both AIG through Spitzer’s fiat and Citigroup through Weill’s own evolution were increasingly run in a manner disconnected from those significant shareholders and early leaders.
And I overlooked that. I missed that, the significance of those measures, because I thought the cultures would have had more of a muscle memory, and that the businesses would continue to be well run. But absent those interested owners reigning over their troops, it is extraordinary how quickly you ended up with something like the financial products division in England, exposing AIG to the very core of its survival through mispriced and the collateral burden of the insurance policies for no premium.
I figured that out late in the chase, and sold them at a much higher price , but did not shower myself the glory from that investment and in part because I probably was, you know, so enamored by even the weakening, growing reports of their exposure from the emerging markets.
I kept overweighing those in hindsight and under-weighing the grumblings of rumors that they were taking up liabilities that I could not get access to. I asked the chairman, CFO and the CEO and they suggest that all those exposures would ultimately prove profitable, and assured us that the accountants required too big of a mark-market discount. The management assured us that they would not in fact be so severe upon maturity and they just had to wait until the maturity. And of course it was a complete nonsense and the appeal of the international insurance world for AIG, was completely misguiding, because the risks that they were taking on were so enormous.
15. What do you think of the companies now?
Tom Russo: Their global franchise has been shrunken sharply. They sold off lots of pieces of their franchise to try to get off the hook from the government. The government protection has given them a checkbook that has allowed them to be very disruptive over the past say three years. General accounting, general terms of the industry as those with whom they compete suggest that they have competed with the benefit of the shorter term capital then they would have had without Government support, and therefore undermine the naturally higher premium that would have surfaced in the market in light of the massive hemorrhaging that represented AIG.
It never surfaced in the market because the government backs up that risk and so AIG then was free to continue to operate in a way that did not probably bear the full cost of the riskiness. And to this day, I do not have an opinion about the general business because so much business separated from the parent through sales.
I know there are some very, very, very smart investors who have made extraordinarily large investments in the company and I respect them and watch with interest how that might unfold.
But for the time being, I remain squarely on the sidelines and to the place that’s on the field on that particular case. I am on the playing fields as it relates to the growth in the emerging market consumer having a loyalty to brands or the capacity increasing to pay for them because they are aspirational and they can have great affordability. And the proposition that our leading participants in those regions have managements who have the capacity to suffer through the early burdens to report the profits that come from proper investment in those markets despite the impact that appears on the income statement.
If these companies continue to nourish their brands heavily to meet future demand, we should be able to foreclose future entrance, and to enjoy a very healthy return from those parts of the world that I think over time will have growing currency values and so there is a benefit for an American investor. The payback on investments should be well made, and potential benefit that comes from protection against growth and currency that is abroad.
Note: Additional interview with Tom Russo can be read on this edition of Graham and Doddsville (
Graham & Doddsville - Issue 15 - Spring 2012.pdf (Size: 3.99 MB / Downloads: 6)
). It also contains interview with Julian Robertson and Jim Chanos
