Discount season

As grim as equity markets appear to be, Ian Lapey maintains that buying opportunities abound.

“We are getting unbelievable bargains – great companies with extremely strong balance sheets that we are buying at 50 cents on the dollar,” says Lapey, 42, a portfolio manager at New York-based Third Avenue Management LLC, who oversees the $320.9-million AIC Global Focused. “We are getting the biggest discounts we have ever seen. And that’s based on the experience of our chairman, Marty Whitman.”

Whitman, founder and co-chief investment officer at the firm, has seen numerous bear markets in his time. “But there’s been none like this [market],” says Lapey.

Given the house style of striving to buy stocks that are “safe and cheap,” Lapey has added to existing holdings such as Tokyo-listed Toyota Industries Corp. Besides a 6% share in Toyota Motor Corp., the holding company has several manufacturing divisions that make items ranging from diesel engines to automotive air conditioners.

“You can get the manufacturing businesses for free now. The value of Toyota Motor actually exceeds the common stock price,” Lapey says. Importantly, both the holding company and Toyota Motor are well financed, which will give them an advantage against the struggling Big Three American car makers. “Toyota stands to benefit in the U.S. and should continue to pick up market share against GM, Ford and Chrysler.”

Toyota stock recently traded at 1,880 yen, down about 58% from its 52-week peak of 4,880 yen. But Lapey calculates it is trading at a bargain basement 50% discount to net asset value.

“We think the stock could certainly double in price,” says Lapey. “And if it did, it would still be cheap. That’s true for a lot of our companies. They could go up significantly, and still be attractively valued.”

When selecting companies, Lapey and the team of 22 analysts and portfolio managers have three basic requirements. Firms must have very strong balance sheets and little or no debt. Second, management teams must have impressive long-term track records whose interests are aligned with outside investors. Third, the underlying businesses should be easy to understand.

“Our investment process is very document-driven and involves a thorough review of the financials,” says Lapey. “If the disclosure is poor, or if despite the good disclosure we can’t understand the business, we take a pass. We will look for things that we can understand.”

Although the team screens hundreds of companies, only 20 make it into the portfolio of the three-year-old AIC Global Focused.

Holdings can go as high as 10%, but currently the largest position is 7%. Turnover has been modest at 21.75% for the 12 months ended June 30.

Lapey worked briefly as a housing analyst at Salomon Brothers, and then fulfilled that function at Credit Suisse First Boston. In 2001, intrigued by Whitman’s investment philosophy and focus on balance sheets, Lapey joined Third Avenue. He oversees about US$2 billion in assets.

Although Lapey does not pay heed to geographic weightings relative to the benchmark MSCI World Index, he prefers markets where investors are protected by good securities laws. “Asia is a huge area for us.”

In this vein, Lapey has bought more shares of the South Korean steel producer Posco, the fund’s largest holding. “It has a phenomenally strong balance sheet,” says Lapey. “Even in the 1998 Asian crisis, its operating margin never fell below 10%.”

Posco stock is down 65% year-to-date, “despite very strong third-quarter operating results,” says Lapey. Yet he believes that the company should be able to take advantage of the current economic malaise at the expense of competitors that have significant debt on their balance sheets.

In the short term, the firm’s concentrated value style has not mitigated the impact of the steep market downturn. In fact, the fund’s 12-month loss of 34.4% to Nov. 30 is worse than the median loss of 32.5% in the Global Equity category. But the fund has fared better on a three-year basis, with an average annual loss of 5.7%, versus 7.5% for the median fund.

“Unfortunately, we cannot predict what the market will do,” says Lapey. “But the companies in our portfolio are likely to prosper in what increasingly looks like a deep, global recession..”

Michael Ryval is a Toronto financial writer.