“Finding a cheap stock price is the Coca-Cola formula” | Interview (elEconomista)16/01/2023
Last year, Azvalor obtained an excellent performance from their international equity fund, with a return of almost 46%, enabling them to reach the top of the Global Active Management League (Liga Global de la Gestión Activa) of ‘elEconomista.es’.
Azvalor CIO’s, Álvaro Guzmán and Fernando Bernad, do not grant many interviews, neither when their funds perform poorly nor when their investment process finally begins to bear fruit, with a return of almost 46% in Azvalor Internacional and 19% in Azvalor Iberia last year, enabling them to be the winners of the Active Management League of elEconomista.es. After the good results obtained investing in energy and commodity companies, the managers are now in the middle of a rotation process towards other types of stocks, but they prefer not to talk about them to avoid being copied—as they claim it has happened before. But they are convinced of the potential that their portfolios still hold, with valuations which they describe as conservative.
What happened in 2022 that caused the funds perform so well?
Álvaro Guzmán (Á. G.): Our portfolio is very conservative, unlike what many people may believe because of the companies held in it. It was conservative because it was bought at such a cheap price that it was difficult even for a bear market to drag it down. The proof is that the portfolio rose almost 50% when the market fell 20%, which was spectacular.
Fernando Bernad (F. B.): The types of sectors in which we have invested in recent years are particularly uncomfortable for some investors. We do not care about volatility; we only care about price and value. We are also more patient than other investors. These are sectors that require an in-depth analysis of the entire industry, and of all the supply and demand, plus an understanding of each product’s unit economics. And that requires a lot of dedication and work.
Á. G.: The temptation is to simplify and think that we had almost a 50% increase because we were invested in commodities, uranium, copper, etc. But this is not the proper explanation. Firstly, some firms went bankrupt. The proof is that, if you had invested in a commodity ETF, you would not have earned that 50% because that type of ETF contains mostly oil firms, and our largest weighting has not always been oil. To beat the market, you have to meet one of the following requirements: to know something that the others do not know, which would be confidential information and this is forbidden; to analyze better than the rest, which is what we try to do; or to have some behavioral bias in your favor that forces the other party to sell. Our two sources of alpha are always analytical skills and not being forced investors. Wherever there is noise, we go, instead of leaving, because there is a risk premium. And where there is a risk premium, we can add something.
In the case of Azvalor, the market already recognizes the analytical part. Since 2015, when the company was created, the annualized return has been approximately 12%. Do you see more potential in the portfolio than what you have historically been able to achieve?
Á. G.: I would say the potential is slightly higher, of around 110%, compared to a historical average of 80-85%. A more qualitative answer would be that, although the indices fell 20% last year, there was a lot of deterioration underneath, with some companies falling 40-50%. We have a list of around 85 analyzed companies that are already getting very close to a price at which we could buy them without any problem.
F.B.:We have been preparing for this for a long time. I insist that the international equity fund is worth more than the 450 euros we assigned as its target value. We are very conservative in our valuations. Our experience is that, in 90% of the cases, the companies exceed our target price. Sometimes they exceed it for so much that it is even embarrassing, because they go up by more than 100% of the target price. That happens to us all the time.
Every time you change a stock in the portfolio, how much does the fund’s potential increase?
Á. G.: When you sell a stock with 10% potential and buy another with 100% potential, you are creating value. And vice versa. In March 2020, with Covid, the NAV of the fund was 60 euros per share and its target value was 215 euros. Now the NAV is 220 euros and the target value is 450 euros. Somehow, the portfolio was logically cheaper at that time. That is why every Friday night we take the portfolio’s price and value and look at the stocks with less than 40% potential to see why they are in the portfolio.
F.B.:We keep upgrading the portfolio not only by including new stocks but also thanks to the opportunities generated by the volatility of the stocks we already own. Canadian Natural Resources starts the year at 40-something dollars, in the summer it reaches 70 dollars and, in a matter of two months, it drops to 45 dollars and then we buy again. We are constantly creating value even with recycled ideas.
During Covid, seeing the potentials generated by your own valuation, did you have historic moments to leverage on some investment ideas?
Á. G.: We are robust in our investment process. What if, instead of rebounding, as it occurred later in March 2020, it had fallen another 40%? In 1929 it plunged 80%. What we do is very boring because we always do the same. There is an obsession with earning extra when it is so cheap, so people leverage… That is not necessary. It is a long-distance race, and if you want to arrive first, the main thing is to arrive. You don’t need to do anything strange, you just need a fully articulated investment philosophy. The key to everything is how you determine the target price to generate a 15% annual return.
How do you maintain the investors’ convictions when they are most nervous?
F.B.:Trying to time the market or the fund is one of the most difficult things to do. You must invest for the long term and forget about the noise, because you will make mistakes. The best time to invest is every time you have savings.
Á. G.: That moment is when it is most necessary to convince our investors. That is why Azvalor’s sales team plays a very important role. People try to buy when it rises sharply and sell when it falls. But with us, buying as it falls has always worked well. One of the biggest inflows was on Brexit day. Not being 100% invested is a small drama but it is better than being underinvested. One of the management companies’ temptations is to lower the investment level, especially when things are going well. No one ever does the right thing in the midst of success. No one makes a good decision after success. Success teaches you nothing, failure teaches you everything. When things go well for them, management companies with a lot of experience have historically lowered the investment level to avoid liquidity. We are a bit paranoid about this. We do not lower the level. That means we have to keep analyzing companies with the same intensity, the same depth, the same angles, in terms of assets, people, competition, the regulator, the company’s ecosystem, etc., and we have to keep buying at half of what they are worth, with some exceptions. Otherwise, you will ruin your track record, as Seth Klarman warns.
Why is it believed that the decade-long loss in value will be recovered?
Á. G.: In terms of returns, it is indisputable that it has been a lost decade. However, in terms of value investors, it has been a marvelous decade, especially since the middle of that period, because that is when we started to sow the value that we are now reaping. The categories used in the real world are not the ones that the fund managers use. It is highly unlikely that price and value will not converge in the future. Companies such as Amazon or Tesla, which have risen sharply in recent years, suddenly find that investors do the math and they suffer drops of 50% in the case of the former and 80% in the case of the latter. Not buying Terra at the time was not a mistake—because we have different analysis categories. We had a few dry years, the most difficult were 2013, 2014 and 2015, but the results are there in terms of value. It was wonderful to buy First Quantum shares at 1 dollar in 2016 as they are now at 30 dollars!
F.B.:Between 2016 and 2019, the number of cheap companies continued to be very scarce in general. The discrepancy in valuation between the most expensive and cheapest companies has been at a record high in recent years, comparable only to the 1999-2000 period. Before last year’s fall, the stock market had seen a discrepancy between expensive and cheap companies which occurs very few times in a century. There is still a long way to go for convergence.
How have you strengthened the international fund portfolio?
Á. G.: Our day-to-day work is to make the portfolio cheaper by analyzing the stocks to be included. Three circumstances must be met for this: Firstly, it must be a comprehensible company about which we can predict—with a 90% confidence interval—where it will be in the next five years. To begin with, that filter excludes many companies such as banks and insurance companies outside Spain, local businesses connected to local governments such as construction and real estate outside Spain, and all the businesses with a very high technological and obsolescence component. About the companies that remain included, we need to see who manages them because, in this business, to invest well in the fund means not being cheated. We need to see if the company’s entire ecosystem conspires for the shareholder to win, and that requires analysis. When you have both, i.e. a company that you can understand and which is run by good managers, you need the main thing: the ability to buy it cheap. To achieve this, you will need a passing cloud or storm. The most important part is how to get a cheap price. That is the Coca-Cola formula. There are negative situations, i.e. clouds, which we do not like at all and frighten us, so we do not touch them, and there are others that we are familiar with, which we have already been through, that are likely to generate comfort if they are analyzed, and those are the ones we approach.
What ratios do you analyze to decide if something is cheap?
Á. G.: This is a qualitative issue, much more than a matter of ratios. If I cannot see where a company will be in five years and I do not trust its management, it will be very difficult for me to invest because the market will test you with a fall of sometimes 50% at any time. And at those moments, your comfort comes from thinking that you have bought a house on the corner of Serrano and Goya Streets [prime area of Madrid], and not a ratio.
What type of ‘clouds’ do you like?
F.B.:It is more difficult to talk about categories now because the companies we are looking at share very few things.
Á. G.: Maybe there is a common denominator and that is the United Kingdom, with the fall of the pound, but many companies are small and liquidity is very important for us. I would say all the macro clouds in the world… When you see a non-investable country, we are there but sometimes we do not understand it. Technology has been highly punished; we are looking there but we have not found anything yet.
In such a good year for yields, you have only raised about 200 million.
Á. G.: We are surprised by the small inflow. That situation is being reversed. We keep telling our story and it is important that people come on their own, after understanding it, because the market will test us and they will not leave then. Maybe not much money is coming in right now but, at the Covid lows, not a single euro left, and that is what this business is all about. We are very clear that this is a kind of family office where we invite some people to join.