After one of the longest underperforming decades for value investors, Mark Costa is finding buying opportunities for the five-star Brandes Canadian Equity Class mandate. Costa director of the investments group at Brandes Investment Partners in San Diego, is one of four managers on the fund.
“We went into the COVID 19 pandemic,” says Costa, “with a focus on positioning, and took advantage of a lot of businesses during the sell-off. We were more aggressive, and then coming out of the pandemic, we took a more conservative stance.”
This isn’t Costa’s first rodeo. With more than two decades of hindsight, Costa says the team has experienced the dot-com market burst, the great financial crisis, the energy sell-off in 2014 and 2015, and now the Covid pandemic.
“We tend to shift our focus from returns to preserving capital, depending on where we are in the market environment,” he says.
“We also manage global products,” says Costa, “and so we’re looking at Canadian companies in the context of how they sit in the global sphere. I think that nuance we bring to the value of companies in Canada really gives us an edge.” The portfolio is positioned with approximately 55% in Canadian equities and 28% in global equities.
A Focus on Fundamentally-Driven Value
The team’s approach to value is based on the Graham and Dodd’s philosophy of fundamental, in-depth analysis, seeking healthy companies at a discount to their estimated business values. The strategy is benchmark agnostic, with a long investment horizon that spans three to five years or more.
The stock criteria include free cash flow characteristics, healthy balance sheets, and strong, durable businesses. The focus is on companies and industries that can survive any market cycle, based on a “deep-dive” analysis on their competitive advantage.
Costa says the typical margin of safety tends to be focused on quality companies at a one-third discount, but sell-offs during Covid offered higher discounts of 70% to 80% in some industries.
Energy Has Become Attractive Now, Fund Owns No Banks
Broad diversification across the sectors is characteristic among the range of 25 to 35 holdings across all caps. The sector weightings reflect the strategy throughout market turbulence. Among the top three sector weightings, energy represents an approximately 19%, financials 15%, and technology about 14%.
The portfolio held zero exposure to energy for a while, but as opportunities have started to open up, Costa says they’ve been able to find more energy names that fit the margin-of-safety principles and conservative balance sheets. The energy exposure includes about 10% global equities, diversified among oil and gas, natural gas, and uranium investments.
Currently the fund has a zero weighting in the banks, differing greatly from the benchmark weighting of around 30% in financials. "Our willingness,” says Costa, “to own zero benchmark weightings in sectors that are overpriced really pays off and we’re seeing that happen today.”
When the market gets frothy and volatile, the managers shift into risk mode with high exposure to defensive businesses and a higher cash position when prudent.
Despite the market turbulence, “I would say that it’s an exciting time today,” says Costa, “because we’re able to find cash-flowing businesses at good prices. Value has been beaten up for so long with stocks that were previously too expensive and we’re able to capitalize on that. We just don’t own a lot of this stuff that’s been crushed.”
Stocks in Focus: What is Costa Buying?
Canadian beverage company, Corby Spirit and Wine Ltd. (CSW.A), is among the top 10 holdings. The company ticks many of the value metrics of the mandate. “Free cash flow, good brand portfolio,” says Costa, “pays a nice dividend, at a 20% discount. That’s a great buy, especially in an expensive market environment.”
Heroux Devtek Inc. (HRX) is an example of an opportunistic holding in the aerospace industry, an industry that was hit so hard during the pandemic. “The company’s whole supply chain,” says Costa, “is very attractive from a growth perspective and favourable long-term potential.” Heroux is a small company but represents the third largest aircraft landing gear of any manufacturer in the world. It has a strong position, and is “very sticky” because of the regulatory requirements that really drive barriers to entry once the product is on an aircraft, adds Costa.
Open Text Corp. (OTEX), a Canadian software company, is a new addition to the portfolio with a long legacy of generating attractive returns on capital. According to Costa, when a client uses the enterprise software, it’s very difficult to switch to a new provider, generating very sticky client contracts. Open Text is also favoured for its reoccurring cash flows, visible growth, and a history of successfully integrating businesses and acquisitions. “And we’re not overpaying for those attributes,” says Costa, “which we like.”
