Transcript: Could World War 3 Curb Your Returns?

Everyone is naturally concerned by Russia’s operations in the Crimean region of the Ukraine, but as investors should we be buyers, not sellers? Owain Bennallack talks cheap Russian stocks with Nate Weisshaar and Mark Rogers. The team also consider a mega-merger that’s created a banana behemoth, take a whirlwind tour through half a dozen upcoming IPOs, and highlight three shares that they think could be attractive right now: BP (LSE: BP) (NYSE: BP.US), Raven Russia (LSE: RUS) and Taylor Wimpey (LSE: TW).

This is a transcript of this podcast.

Owain Bennallack: Hello, and welcome to Money Talk, the regular investing roundtable from The Motley Fool. I’m Owain Bennallack, and with me in the studio today we have two of my most loyal Motley Fool colleagues. We have Nate Weisshaar and Mark Rogers. Welcome back to the Money Talk studio, guys.

Mark Rogers: Hey, Owain.

Nate Weisshaar: Feels like home.

Bennallack: It does feel like home though, Nate, I have discovered that we’re soon going to have to do these podcasts with you on an ISDN line from the U.S. Say it ain’t so — to quote the U.S. vernacular!

Weisshaar: I don’t know that I can say that. My mom always told me that “ain’t” wasn’t a word. But, it is true. I am returning to the mother ship, and will be closer to family, but still my heart will be in London.

Bennallack: Sadly, our budget will not extend to flying you in for the podcast.

Weisshaar: We’ve got to work on that.

Bennallack: We are going to have, in the studio, doughnuts though, Mark. I have finally got those confirmed.

Rogers: Oh, that’s good. Finally!

Bennallack: Yeah, they start, I think, the day …

Rogers: The day he leaves. It’s funny, that.

Bennallack: Weirdly. It’s a horrible coincidence.

Weisshaar: You could only afford two doughnuts, so…

Bennallack: Something like that — although, of course, in the U.S. you’ll be able to buy one doughnut, probably for a dollar, that will be the size of this table, and feast on it.

How we’re envious of you, going to the Land of the Free … lunch. Let’s not go into politics. We’ve got you in the studio, let’s do a podcast.

First of all, let’s go into politics. I think we should look at the recent events in the Crimea — or should I say “Russia,” but a bit pretending, to abide by the official Russian foreign policy? And, we should ask what it means for our investments.

Secondly, Mark has gone bananas … or, more specifically, he’s been looking at a mega-merger to create a global banana giant. Is this more evidence that the stock market has gone mad — sorry — “bananas?” Mark has insisted I make that joke as many times as possible, because he came up with it.

Rogers: Yes.

Bennallack: Finally, to follow that up, we’ll take a super-quick look at some upcoming IPOs, and we’ll give our initial take, our first thoughts, on those IPOs.

Then properly, finally, we’ll run through three companies that we’re interested in, right now.

Okay, I think we should crack on. We haven’t got Nate for much longer, so let’s get going.

It was only a few weeks ago that we were transfixed as Russia hosted the Sochi Winter Olympic Games. But those happy days are over, and attention has naturally turned from Sochi to global events — such as events a few hundred miles further along the Black Sea, where Russia has decided it wants to play host to the citizens of Crimea in the Ukraine permanently, by making Crimea part of Russia.

Mark, what have investors made of this cross-country off-skiing?

Rogers: Oh, God. That was terrible.

Bennallack: Do you get it? Off-skiing?

Rogers: Yeah. Okay, so the Russian market was down 11% in a single day when this really started kicking off. That’s pretty dramatic by normal standards. If you can imagine that happening on the FTSE or on the Dow — what if it lost nearly 2,000 points or something?

Bennallack: Listeners should know that I’ve been expressing some worries about the market at the moment. Mark is trying to make me express those on air.

Rogers: I am. I’m trying to push him over the edge here.

The Russian rouble has lost about 12% of its value this year as well, so it’s all in all been a real capital flight.

Bennallack: Nate, you and I have already had some pretty tasty debates about this, in that I think it’s a done deal. Putin’s being very consistent and rational by his own logic — by the needs of Russia. I don’t think we can push back against it, really, so I think Putin will annex the Crimea. There’s not much we can do about it, and arguably, we will in the “bigger prize” of the Ukraine, anyway.

Therefore, I think for investors outside of Russia, the actual impact should be minimal. That’s not to say people won’t get worried about it, but the actual knock-on should be not particularly significant.

Whereas, I think that you think Putin went perhaps a bit too far, too fast. But either way, aren’t Russian stocks already virtual investing pariahs?

Weisshaar: Yes, Russia hasn’t exactly been a Mecca of foreign investment. The question about rights to assets, the rule of law, have really put investors off. National companies like Gazprom is trading at 2x earnings. Compare that to almost any — even troubled — oil companies like BP, and that’s just an atrocious valuation.

Bennallack: It’s astonishing, isn’t it? Lukoil, another one in the dumpster.

Weisshaar: Lukoil, trading around 6x earnings — slightly better, but still — this is just another example of Russia playing by its own rules, which investors really don’t like because they have no assurance that what they’re investing in will be there the next day.

Bennallack: Yes. It’s one thing to read in the history books that you can buy shares when they’re on P/Es of three or two, but when the opportunity comes around, there always does seem to be a snag!

But say I’m a wild contrarian. Perhaps I’m channelling the late Sir John Templeton, who used to scour the world for unloved trouble spots, and then invest there — possibly he’d be investing in Russia now; he’s not here to tell us what he’d be doing.

If I was going to take a leaf out of his book, how would I invest in Russia?

Weisshaar: Well, there are several funds that will allow you to do it. The Neptune Russia & Greater Russia Fund, the Jupiter Emerging Europe Fund, which is 44% invested in Russian stocks, and the JPMorgan Russian Securities are all interesting ways, if you want to gain some exposure.

They were all hit quite handily on the dramatic day. They’ve had a little bit of a bounce-back, but they’re still well below … I think each of them is down about a quarter, over the past year.

Bennallack: I found an ETF as well, a tracker fund, and it was interesting because it was called “25% capped,” which meant that no single position could be over 25% — as in, one company in the fund — which seems crazy, until you look at, I think the top three holdings made up over 50% of the tracker, so this possibly is a market where looking to the managed funds might be better than going via a tracker, I suppose, from a risk perspective.

Weisshaar: Yes, there just isn’t a whole lot of liquidity in the Russian market. Their major index is the 50 most liquid shares.

Bennallack: There are a lot of Russians in London, and over the years there has been some Russian activity on our stock market, hasn’t there, Mark?

Rogers: Yes, another option if you’re looking for exposure to Russia is to look at U.K.-listed firms on the London Stock Exchange that have that exposure. I want to talk about BP later on, so I want to avoid spoiling that for listeners now.

But there’s also a small company called ITE Group which I think is pretty interesting, that holds trade shows and exhibitions in both Russia and Ukraine, so that’s a pretty tasty area to be in, given recent events. But that one’s taking a real pasting in the last few weeks. It’s one to look at.

Bennallack: I think there are still some Russian miners as well, despite their fleeing that’s happened recently. A couple of them have left the market, but there’s Polymetal — that’s Russian, isn’t it?

Weisshaar: Yes.

Bennallack: Moving on from risking World War III, but staying with bananas news, last week we saw two of the world’s biggest banana producers do a mega merger. Mark, how does this deal stack up, and should banana fans — which I am one — should we be fearful that we’re going to be paying a massive premium for our yellow fruits?

Rogers: Yes, that’s actually been a concern that’s been raised as a result of this. Basically, Irish-based Fyffes is going to merge with U.S. giant Chiquita, to create what the BBC called a “Banana Behemoth.”

Bennallack: It could be the plot of a James Bond movie.

Rogers: It really could. It’s a terrifying James Bond theme. This is just going to be a billion-dollar company. It’s going to be 14% of the world banana market. It’s going to be the number one player, so it would be in a pretty dominant position.

Bennallack: It’s been great for investors in Fyffes shares, hasn’t it?

Rogers: Yes, the deal that’s been struck puts Fyffes shares at a 40% premium in this merger, which is, I think, a terrific deal for what has always been a relatively undervalued share, I’ve thought.

Bennallack: There’s still a possibility that the deal won’t go through.

Rogers: That’s right, yes. The deal is still subject to Competition Commission approval, here in the EU, and antitrust laws in the U.S. might prevent it as well.

Bennallack: Personally, I’m hoping the deal does go through, but then it’s reversed in a few years so we can crack jokes about banana splits!

… I’m not even getting a groan on that one.

Nate, more seriously, does the size of this deal, and perhaps some of the other signs we’re seeing in the market at the moment, worry you at all that things are getting a bit frothy? A billion-pound banana merger? Is that a bad sign?

Weisshaar: Well, you yourself are a fan of bananas, so you can see the appeal here. But I think this is a little less worrying, perhaps, than maybe the $19 billion that Facebook put out for WhatsApp. But there are signs that things are getting a little bit toppy.

Famous hedge fund manager Seth Klarman has recently put out his letter to shareholders and said that we’re seeing some nosebleed valuations. He’s particularly concerned about the tech industry. In fact, last year his fund returned $4 billion in cash to investors because he just couldn’t see ways to use that money.

So, there are some people who think that we’re looking at some ridiculousness, but you’ve made some very cogent arguments about why the Facebook acquisition of WhatsApp may look expensive on the surface, but if you look at the industry implications, it could be a reasonable acquisition.

I think we’re seeing some big money get thrown around, but I’m not quite sure that we’re looking at the ridiculousness that we saw in, say, the late ’90s.

Bennallack: Yes, I think it’s very difficult to tell at the moment because the late ’90s is a dangerous ballpark to use, because it was so ridiculous. One of the reasons I say that is because I remember thinking in 2007, “This isn’t the late ’90s” — and it wasn’t — but that didn’t stop the market going down 50%.

Another interesting thing I saw recently was, I was reading Prem Watsa’s letter from Fairfax Holdings — he’s a sort of Buffett acolyte, as you know, in Canada — and he’s got billions in hedges on, because he’s so nervous about the market and what the Fed has done, particularly in the U.S. He sees deflation down the line.

That came two weeks after Buffett’s reasonably upbeat letter … perhaps not as upbeat as he is sometimes.

Rogers: Well, he does tend to take the long-term, “Things will be all right in the end” sort of view, Buffett.

Bennallack: It’s true, but I think it’s interesting that two people who are both value investors reach such different conclusions. On the other hand, I do think that we have been through a pretty dark period, so we do have to be cautious about getting too jumpy just because there are some signs of activity in the market.

Weisshaar: I’d also point out that Prem has been shorting, or hedging, his market exposure for years, so this isn’t exactly a change in direction for him.

Bennallack: Yes. We can’t really tell whether he’s going to be vindicated, or if he’s sticking to his position as the ship goes down. It is hard to tell.

Going back to the deal, just briefly, you and I often talk about the potential attractions of investing in agricultural and soft commodity companies — the “Feed the World” theme. This deal seems to be as much about saving money, really, for the two companies as any future boom in foodstuffs, though.

Weisshaar: Yes, I think this situation is more of a “Let’s get better together” type thing than banking on the population growth and rising demand for food from wealthier consumers. The banana is a major staple for some countries, but worldwide it’s not exactly a vital part of the diet.

Bennallack: Is it elastic, the demand for bananas?

Right, let’s move on. The IPOs, as we’ve alluded to in that little section about activity in the market, are coming thick and fast in recent months. Obviously, everyone but me was allowed to buy Royal Mail shares, and you all made out like bandits. Good for you.

But we’ve also seen successful IPOs for visitor attraction giant Merlin Entertainments, digital dishwasher peddler Appliances Online floated very successfully a couple of weeks ago, and there are more on the way. So, I thought it would be fun to give our first thoughts on a few of these upcoming IPOs.

It goes without saying, so I’ll say it once to avoid repetition from us all, that this is far from an in-depth verdict we’re about to give here. I think I probably speak for all of us when I say our general view is that IPOs are seldom the time to go looking for bargain shares. If people have decided to sell their company, usually it’s because they think they’re going to get a good price.

Rogers: Right.

Bennallack: I’m going to give this section a silly name, to underline the point. We’re going to play Imminent IPO, Hot or Not? I’m going to name five or six upcoming IPOs, and we’ll each give our quick verdict and one short sentence — and you have to say “Hot” or “Not,” because otherwise …

Rogers: It ruins the game.

Bennallack: It doesn’t work, does it?

Weisshaar: I don’t see what’s silly about this at all.

Bennallack: It’s a generational thing, I think, Nate. You’ve grown up liking and disliking everything, as a reflex.

Okay, here we go. The first one is going to be Pets at Home, and I should say that that IPO is closing as we record this podcast, so we could all look silly by the time you hear it, but Mark, Pets at Home.

Rogers: Not. I like Matt Davis, the ex-CEO who’s now the Halfords CEO, but it’s got too much debt for my liking.

Weisshaar: I say Hot, because the strong customer culture seems to resonate, and I think that that’s a great direction for a company to go.

Bennallack: I’m going to say Hot as well, because people love their pets, and they’ve got a massive membership base, as you suggest. So, I think that that one, they may actually … I take on board Mark’s points, but I think it may be hot.

Next, Poundland.

Rogers: Not. No pricing power; you can’t sell stuff for a pound 10 years from now and be making the same margins.

Bennallack: Nate?

Weisshaar: They can always just change their name.

I’m going to go with Not, as well. It’s a very difficult industry to break into, and there’s tons and tons of competition.

Bennallack: I’m going to go Not, but there is a shop near me that’s called 97 Cents Land, which opened quite recently.

Rogers: Already being undercut.

Bennallack: I don’t understand, like you, unless we face Prem Watsa’s deflation hypothesis, how it’s going to be selling things for a pound.

Rogers: Like an upmarket retailer.

Bennallack: Exactly, so you can buy a Tesla for a pound.

Trendy outdoors clothing retailer Fat Face is coming to market. Nate, let’s go with you first. Hot or Not?

Weisshaar: Hot. Who wouldn’t want that name on their clothing?

Rogers: Not. I have no idea what they’re worth, I’ve never been in one of their shops, and I probably would never wear any of their clothing.

Bennallack: Hot. I can literally get anything from there for my girlfriend, and she likes it. But to go to Nate’s point, she isn’t a native English speaker, and she bought a leather bag. Her mum was looking at it and admiring it, and then she said, “What is this? Fat Face? What does this mean?”

So, I think — Nate you’re probably best placed to answer this — but is it a reference to a mountain? Is it like a “fat face” that you can climb up or something?

Weisshaar: It’s possible. I’ve just laughed at the store, usually.

Bennallack: OK, well I think we’re going to outvote Mark on that one. Looking at him, I think we’re safe.

Rogers: Yes, okay.

Bennallack: Mark, here’s one for you. Oldie lifestyle supporter, Saga. Hot or Not?

Rogers: Not. Yet again, too much debt. The company could be worth £3 billion, it’s got debt of £4.6 billion. No.

Weisshaar: Wow. That’s a lot of debt. Even beside the fact that old folks are a growing client base. I would say Hot, just because I think that this is the right market to be aimed at.

Bennallack: You and I have got too much in common, Nate, today. I’m going to say Hot as well. They are making more old people every day.

Department store, House of Fraser.

Rogers: Not. Yet again, too much debt; £250 million worth of debt, the company’s only worth £350 million. It’s expensive debt, and you’re not going to get a good deal compared to Debenhams, which is probably the cut price, relatively.

Weisshaar: I’m going to come down on Mark’s side and say Not. However, I will say that House of Fraser is doing some interesting things with their “Mobile First” web applications, which is more forward-thinking than I was expecting.

Bennallack: I’m going to say Not also, because we have seen this story before, with the debt and whatnot. However, I have bought, I realised when thinking about this piece, two Ted Baker pieces of clothing, ironically, from House of Fraser online. So, as you say, they’re doing something right technologically.

Finally, the “Didn’t they read the history of the original” company, Internet fashion retailer

Rogers: Boo who?

Bennallack: That’s very short. You haven’t said Hot or Not, so it does not compute.

Rogers: Okay, the business could be Hot. I don’t know, because I’ve never been to But at £560 million, no. Not.

Weisshaar: I’m going to say Hot. I think that it’s at 6x sales right now, but the sales are minuscule in the scheme of things, and I think the fact that they are an online retailer and they have opportunities for international expansion … I’m giving them a thumbs-up.

Bennallack: I’m torn here, because I want to say “It’ll all end in tears.” But I am actually going to say Hot, because I think probably — even though I am a bit nervous about the market — I think probably there’s a last gasp in it for this kind of stock. I think you’re right, 6x sales almost sounds cheap in fact, for these crazy companies, so possibly that one will …

That’s not a reason to invest in it for the long term. That’s more of a …

Rogers: No, I think all of these things could potentially fly from the open — there’s no denying that. But in terms of, from our point of view for a longer-term, slightly more sensible investment standpoint, none of these interest me.

Bennallack: We’ve got to remember, all companies in the stock market once IPOed, so by definition we’ll get another chance to look at these companies, maybe at a cheaper time.

Rogers: Maybe.

Bennallack: Well, as I say, that was just for a bit of fun. Don’t go cashing in your pensions and getting your money ready on those recommendations. Having said that, I will keep track of all Mark’s claims for Hot or Not, and I’ll highlight any that do particularly badly in a year’s time.

More seriously, Mark, what other share have you got your eye on this week? Well, we know in fact it’s BP.

Rogers: Yes. Well, with all the geopolitical events recently, I just thought it would make sense to root around in Russia to see if I could find any contrarian opportunities. So, I took a close look at BP, which owns just under 20% of Rosneft. It’s a tie-up in the Kremlin-backed oil giant.

However, looking closer at it, it’s not like the shares have tanked or anything as a result of recent events. I think what’s hanging over the shares is still what’s been hanging over the shares for the last four years, which is the spectre of the Gulf of Mexico oil disaster.

Now, I’m not the biggest fan of BP’s economic position. I don’t think it’s a fantastic business or anything, but I think it’s a solid, if not spectacular, opportunity and I think it’s undervalued. I think you’re getting a decent deal with the 5% yield there, and I think so long as you don’t wait for things to look perfectly rosy for BP and you take the plunge while they’re out of favour, I think you’ll do relatively well.

Weisshaar: I’m just wondering when things are going to look rosy for BP. The Gulf of Mexico has been hanging over the company for years now, and the legal battles keep seem to be going against the company.

Then you’ve got major shareholders who are pushing for the company to stop exploring, so this is one I’m a little confused about.

Rogers: Yes, I think the last point is a good one. I am actually quite a fan of their change in strategy towards finding fewer projects that are more lucrative, from a shareholder standpoint. It’s not like going all-out for growth has been great for BP shareholders to date.

But, to the first point, I love the fact that it doesn’t seem like there’s an end in sight for BP. That, to me, tells me that maybe I do want to take a closer look because it’s when it seems like there’s no end in sight that quite often you’re in a situation where the shares are going to be depressed, almost naturally. So, I’m relatively interested, more so.

Bennallack: Something I would say to that as well is they had a really good replacement reserve year last year, because all that Russian exposure has given them a lot of reserves. The problem is, of course, it’s Russian exposure. I refer you, to the earlier section of the podcast.

Nate, I assume you’re not saving all your pennies for the float of, let alone Fat Face.

Weisshaar: Most of them, but not all of them. I’ve got some set aside. Following on to our previous conversation, I’m looking at Raven Russia. It’s an amazing name for a company that owns warehouses. All the warehouses are in Russia.

They’ve recently had results, and they’re now reporting that 97% of their warehouses are rented out. As this was a progressive thing throughout the year, this year’s numbers do not represent what the rent income will be next year, so there’s some good progress there.

Bennallack: I think they’re an interesting company. I’ve looked at the preference shares a few times and it’s interesting the way they’ve structured it. Knowing that they’re in Russia, they sort of ring-fence some of the assets, and they “de-Russiafy” some of it, for want of a better phrase.

But ultimately, if we start imposing economic sanctions on oligarchs and whatnot, is there not a danger of tit-for-tat from Russia?

Weisshaar: Sure, there is. I’m just uncertain that sanctions against Russia will be effective, mainly because Russia has this big trump card in its natural gas, that fuels most of Europe. Although we are moving towards warmer weather, we do tend to appreciate having cheap gas.

Bennallack: I think we had a 45-day stockpile, last I read, so yes — good luck with that, EU.

Finally my share, which is going to be Taylor Wimpey, the U.K. housebuilder. Now, I bought this too soon because I thought it would go into the FTSE 100, or I thought there was a reasonable chance, and it just missed out. Now it’s been selling off — I wouldn’t say dramatically heavily — but it’s down about 5 or 10%, which is interesting given that we’re in the middle of a nascent housing boom.

Taylor Wimpey is also doing some interesting things. It’s decided it’s got far too much land. From memory, it’s got about 10 years in its land bank and say, Barratt only has about 4.5 years, so it’s going to sell off a lot of that land into what is a red-hot market for land, and it’s going to do a cash return to shareholders.

It’s not cheap on a price-to-book basis, but on an earnings basis it doesn’t look too bad, particularly if you look forward a couple of years and assume that the housing recovery is going to continue.

So, I think people are selling it partly because they bought it thinking it might go into the FTSE 100. Maybe also there is a sort of a seasonal factor here, where housebuilders tend to do best from autumn to the start of spring, so maybe people are trying to get ahead of that.

If you’re going to tuck them away for a little bit, I think that U.K. housebuilders are possibly one of the secular stories that still has quite a long way to run.

Rogers: Owain, you mentioned earlier that you’re generally starting to get a little bit worried about the stock market. Obviously, the housing shares have had a great run. Do you think that there’s a bit of over-hype in this nascent housing boom that you mentioned?

Bennallack: I don’t really think so. I think the big worry is that interest rates rise faster than anyone expects. I saw an analysis the other day of what would happen if Bank of England interest rates got to 3%, which is not very high, and it wasn’t particularly pretty — so that’s probably the big worry.

But you’ve been out looking for property recently.

Rogers: Yes, that’s true. Yes.

Bennallack: It’s just insane. I think, at the moment — housing markets tend to move longer than stock markets, and they take longer to turn around — so I think there’s probably enough legs in it to at least get another burst of optimism and get Taylor Wimpey up to about £1.50. At some point, they’ll be far too expensive and you’ll need to sell them; that’s definitely true. They’re a cyclical company.

Rogers: Yes, okay.

Bennallack: Okay, chaps, I think we’ll call it a day there. Hopefully we won’t leave the podcast studio and find the four-minute warning sirens blaring, as a response to events in Ukraine. We’ll see you next time.

Rogers: All right, see you guys.

Weisshaar: See you.

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Owain owns shares in Taylor Wimpey.