David Herro, Chief Investment Officer for international equities at Harris Associates, is bullish on Credit Suisse and demands more clarity on the Holcim merger.

About David HerroDavid Herro has been a manager of the Oakmark International Fund since 1992, the Oakmark International Small Cap Fund since 1995 and the Oakmark Global Select Fund since 2006. He is also the Chief Investment Officer for International Equities at Harris Associates, which he joined in 1992. His career honors include being named Morningstar's International Stock Fund Manager of the Year in 2006 and International Stock Fund Manager of the Decade for 2000-09. Mr. Herro has an M.A. in Economics from the University of Wisconsin-Milwaukee (1985) and a B.S. in Business/Economics from the University of Wisconsin-Platteville (1983). Institutional Investors from the United States are usually quite private and don’t speak publicly about their investments in Swiss companies. But not David Herro. The successful value investor from Chicago, who tracks down cheap stocks with big potential and is a member of the renowned “Barron’s” Roundtable, speaks out clearly, what he thinks. For Harris Associates, he manages three international stock funds which in total count over $30 Bil. of assets under management and hold substantial positions in Swiss businesses like Credit Suisse (CSGN 25.91 0.74%), Richemont (CFR 79.65 0.06%), Julius Bär (BAER 49.73 0.04%) and Panalpina (PWTN 143.4 -0.21%). Mr. Herro is highly critical of the recent developments at the building supplier Sika (SIK 3475 -0.74%). Also, he doesn’t want to approve the merger between the cement giants Holcim (HOLN 73.05 -0.48%) and Lafarge (LG 61.15 -1.32%) without knowing who’s going to lead the new company. What’s more, he thinks the new management at the airline catering firm Gategroup (GATE 33.3 0.3%) deserves a chance.

Weitere PositionenMr. Herro, besides being a highly respected value investor you’re also a huge fan of Green Bay Packers Football. Do you see similarities between sports and investing?
In investing you have to analyze a number of different factors. And then you have to focus on what’s important. In football it’s also where you have a lot of moving parts at any moment and if one player doesn’t do his job it can result in a disaster – especially a key player. The same is true for us: You can’t muff it because when we miss something the stock price goes down. In football it’s about getting the most points at the end of the game. For a value investor it’s ultimately correctly analyzing and pricing a business. And you do so in a discipline, thorough fashion and then you have to act upon it. And a big problem with the pressure on investors is that they ultimately don’t have the courage of their convictions.

Why?
They don’t want to be different and as a result of that they end up being average or below average. You have to be able to withstand being different. I truthfully believe that there is a negative trade-off between short term performance and long term performance. If you just try to match the market every day, every week and every quarter you’re not going to beat it over five, ten, fifteen or twenty years. Our objective is to beat the market over the long haul. So what we try to accomplish is to thoroughly determine the intrinsic value of a business – and to us this is really just a function of the free cash which that business generates over time.

Your investments are mostly focused on Europe and especially on Switzerland. How come?
Europe still contains the most value. It contains the most value because people make two mistakes: They assume Europe is completely economically homogenous. But of course, Europe is very different from that. For instance, you couldn’t think of two more opposite countries than Greece and Germany. The other thing is that people assume that where a company is listed is where it earns its money. To prove that’s wrong, all I have to take is the case of Swiss companies like Nestlé (NESN 73.3 0.14%), Richemont or Adecco (ADEN 79.3 0.44%). These are global companies, their cash flow streams are exposed to all over the world. That’s why we think Europe represents good value.

One of the largest positions in your portfolio is the Swiss cement giant Holcim. What do think of the new transaction structure for the proposed merger with French rival Lafarge?
We think it’s a vast improvement. It’s not perfect, but it’s a vast improvement. We haven’t made any decisions because there still remains one question: If we’re going to vote on this deal we want to know who the new CEO is going to be. So we think that this should be announced sooner rather than later.

What kind of skill set does the new CEO need to bring in?
If the company is properly managed and well integrated this should be a very good transaction and create value. Therefore, the CEO has to be someone who is a good operator and who’s also good at integrating acquisitions. This is a capital intensive business and the object is to better utilize and leverage the existing capital. I’m glad they abandoned the first choice because the management at Lafarge has not demonstrated any ability to do that.

What exactly is value to you?
According to Ben Graham a value stock matches the following criteria: a margin of safety, a good balance sheet, a low P/E ratio, and a low price to book ratio. But for us, those are all price indicators. So it’s only half the value proposition. The other half is what you’re getting for what you’re paying or the quality indicators. To us, that’s the return structure of a business and the capital allocator proficiency of that management team. That’s what creates quality and you can combine that with price. Richemont for example, with the Cartier brand is a pretty good mode. It comes up with new things, it’s very inspirational, it’s very attractive to upward movements in wealth in the emerging world and it’s attractive in the developed world. It’s a very well managed brand and they don’t over distribute. They do all the right things. So for this you should be willing to pay a higher price than for a company that makes wood nails.

Especially in the financial sector, capital allocator proficiency is crucial. What do you think of the management change at Credit Suisse, the largest position in the Oakmark International Fund?
I think Brady Dougan was somewhat underrated. He did a very good job during his tenure. He preserved capital. Credit Suisse, more than any other investment bank, made it through the financial crisis. But perhaps it was time after eight years for a fresh look, a fresh leadership, a fresh management. Judging by everything we’ve read and discussed with people who know the incoming CEO, Mr. Thiam seems to be an extraordinarily good choice. So we’re very pleased with the candidate Credit Suisse came up with.

Why do you like Credit Suisse so much?
The case is quite simple. Credit Suisse is a combination of two things: A private bank where you have good mid-single to upper-single digit growth. Second, you have an investment bank which should grow decently as well. And when you combine the two together you have the safety of the private bank and you have what has been since the 2000 crisis a relatively well managed investment bank from a risk perspective. Despite all of that, the shares are trading at a very low valuation level: less than one times book value and a mid-single digit normalized price to earnings ratio. A company that should grow earnings mid-single to upper-single digits is worth a lot more than that.

On the other hand, big banks are like a Black box – you don’t know what’s really going on inside. Doesn’t that concern you?
Well, then you price these stocks as such. Before the crisis, you would have probably said: «A bank has a 20% return on equity so it’s 1.5 or 2 times times book value. Today we go: «No, sorry, it’s just 1 times book value or 0.9 times book value.» So the market values those stocks below what they are theoretically worth to reflect the fact that what we don’t know may blow up. With respect to that UBS (UBSG 18.3 0.16%) was a perfect example.

But today UBS is perceived to be a more secure institution than Credit Suisse.
That’s what people say. But I think it’s hooey. Most of that is perception and I don’t think a lot of that is real. It’s interesting that UBS in comparison to Credit Suisse trades at a huge 50% premium. And all UBS does is stumble on banana piles. And every time they get up they step on another one. So clearly, at this stage and at this price we would much rather own Credit Suisse than UBS.

And what do you like about Julius Bär, the largest holding in the Oakmark International Small Cap Fund?
When we first invested in Julius Bär they had a brokerage firm, they had an investment bank, two classes of votes and all that. Since then, the Bär family has done the right thing. It simplified the shareholder structure and cleaned up all the garbage. This has been requited by the market. But we think the stock should even trade at a higher multiple given that Julius Bär is a pure private bank.

But some stocks trade at a low valuation for the right reasons. How do you avoid such value traps?
The key to avoiding a value trap is to make sure you are invested in businesses whose management is proactively, through time building value per share. If for some reason they destroy value –  systemically or by accident – you should avoid that company. Of course, in the short run there might be an off period when it’s almost impossible to create value. Maybe we’re going through a recession or the company gets hit by something exogenous, like the agricultural equipment manufacturer CNH Industrial on the trough of the agricultural cycle. Those things are understandable. It’s the structural nature of value destruction which is inexcusable. So even if a company is trading at a low price if that management team cannot demonstrate that they are capable of creating value than we’re not invested. Because that’s what leads to value traps.

What’s an example of a typical value trap?
Petrobras. With six times earnings the company has a real low price. But it’s a pile of garbage. There’s an inability for that management to grow the value per share. Their oil resources are way out and way deep and they haven’t come up with a technological solution for that problem. So we don’t even have a quantitative idea how much it’s going to cost to lift the oil up and bring it in. Of course, more and more people are driving a car in Brazil now.  But for every liter of fuel Petrobras sells the company loses money because there is a price control. Also, you have this government involvement, whether it’s with the subcontractors, the dividend policy or the managers they stick on. And now, there is the big scandal with the bribery.

Against this background, how do you get along with the situation at industrial manufacturer Sulzer (SUN 106.7 -0.28%), where the Russian Oligarch Victor Vekselberg controls almost a third of the company?
We were a little scared off by the ownership structure. But not completely scared off, obviously, because we own a fairly big position. We are a little concerned about their lazy balance sheet and about what they might do with it.

What’s a lazy balance sheet?
Too much cash is a lazy balance sheet. We like Sulzer’s underlying businesses and the positions they have. There are some really good businesses like the pumps and the coatings. Also, they have high market shares in some of their special applications. All these things are good. But what we don’t want them to do is to spend their pot of gold on something that’s expensive and that destroys value. So we’ve argued that perhaps they should do a stock buyback or increase the dividend. They announced to increase their dividend and we think that’s a good thing. Supposedly, the barrier to a stock buyback is that the major shareholder then would have a bigger amount and that might force a takeover offer. But you could apply for an exemption. We would think and hope that they would apply for this exemption because we and the other owners shouldn’t suffer. Just look at the worst thing that’s happening with Sika.

What’s your take at the situation there after the board of directors achieved an important victory at the court of the canton of Zug against the heirs of the founder family and the French company Saint-Gobain (SGO 40.725 0.39%)?
This is criminal. Ok, it’s legal, but it’s not moral. That family, they let greed blind them. Their family name is all they have, it’s their reputation. And now, they’re going to be remembered as the people who behaved less than morally on how they handled this. Sika is a great business, a great company and sadly, to make a quick buck, they sold the company and the other shareholders down the river. It’s terrible! Your life is too short and your name and your reputation is too important. That family is not looking at it right. They’re not looking at the impact their business decision has on other stakeholders – the owners of the business, the employees and the customers. Therefore, they really should rethink what they’re doing. I’m the biggest free market capitalist. That’s why I said it’s ok and it’s legal. But it’s reflective of their morality. When we talk about ethics and morals, this is a demonstration of a lack of ethics and morals, clearly. I mean how much is enough?

Another major shareholder battle is taking place at the airline catering company Gategroup. What do you think of the new management that will take over at the beginning of April?
This is something we are carefully watching and carefully considering. We’ve heard from both sides. We are pleased with the management selections that the chairman of Gategroup has made with respect to the CEO and the CFO. Clearly, this is a company that has underperformed. So we think the management changes are welcome. The question is what took so long? It should have happened a year or two ago. But better late than never. So we are supportive of the management changes and we are willing to give the new management team a chance. Of course, there are still issues with respect to the representation in the board of directors but we haven’t made a decision on how we are going to vote on those.

A group of other shareholders wants to elect Mr. Gerard van Kesteren, the former CFO of Kühne+Nagel, to the board of directors. Would you give him your vote?
We would be extremely supportive of Gerard joining the board. We think he is an exceptional businessman. When it comes to the best CFOs in Switzerland I would say two CFOs come to my mind right away: One is Gerard and the other is Dominik de Daniel at Adecco. These are two exceptional business people. They understand their businesses of which they were or still are the CFO. They have the right mentality, they understand the nitty-gritty of the business and they relate to people. They manage for the medium and long term. They don’t just try to quick make a short term decision. They’re very astute business people. So we would be happy to see Gerard on that board.

Would you allow a personal question at the end of this interview? How do you invest your money privately?
I put most of my personal money in places that I’m most familiar with. And there is no more familiar place than our funds. Of my liquid net worth, outside of property and houses and such kind of things, over half of it is invested in the funds that I manage. So I’m not as diversified as I maybe should be. My largest single holding is my position in the Oakmark International Fund, my second largest holding is in the Oakmark International Small Cap Fund and my third largest holding is in the Oakmark Global Select Fund. So I’m like just all my other clients, I’m right there with them. Also, I would ascertain that the results I have achieved are better than the average shareholder because I buy on dips and they sell on dips. So when the funds have a weak period, like we had in August of 2014 and early 2015, I added to my positions.

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