by Will Ashworth | February 11, 2013 8:35 am
Three years ago, the Fairholme Fund (MUTF:FAIRX) was riding a huge wave of success and Morningstar named FAIRX’s Bruce Berkowitz its U.S. stock manager of the year. Then the fund hit the skids, losing 32% in 2011 while the S&P eked out a modest 2% gain. That same year, it also lost its co-pilot in Charlie Fernandez, who moved on to found Barnstar Funds, his own investment business specializing in special situations.
Fortunately for Fairholme unit holders, Berkowitz bounced back nicely in 2012 with a 36% gain. Back in the high life, here are what I believe to be the star manager’s three best ideas:
St. Joe Company (NYSE:JOE) is a firm that’s very familiar to my parents. They winter in Destin, Fla., and St. Joe is the largest private landowner in Northwest Florida with around 567,000 acres. All along the Gulf of Mexico coast and in Tallahassee inland, St. Joe’s develops interesting resorts and communities, one distinct from another. That’s their bread and butter.
No bigger a development is its West Bay project encompassing 71,000 acres on the outskirts of Panama City. St. Joe is building a community over a 50-year period that will have 4.4 million square feet of industrial, commercial and retail space, some 27,000 residential units along with 900 marina slips. West Bay represents 45% of the company’s commercial development and about 25% of its residential construction. It’s so huge that the company donated 4,000 acres for a new airport that opened in May 2010.
The Fairholme Fund owns $480 million of St. Joe’s stock, which represents about 7% of its overall portfolio. Berkowitz paid $26.26 per share between December 2007 and October 2010 for the 23.1 million shares it currently owns. That means he’s still underwater by a little more than $3. In his 2012 report, Berkowitz mentions that housing prices, while up, have yet to reach replacement value, providing good upside potential for St. Joe. The fund’s investment is definitely a bet on the housing sector improving. With Berkowitz still holding 25% of its shares, I like St. Joe’s chances in the next three to five years.
Bruce Berkowitz believes, just like Charlie Munger, that you invest in your best ideas. Clearly, with 42.3% of its assets invested in the property and casualty insurer, you can’t highlight his best ideas without picking American International Group (NYSE:AIG).
In 2012, AIG’s stock gained 52% which, given Fairholme’s massive position in the insurer, explains why Berkowitz outperformed the S&P 500 last year by 20 percentage points. Up 9.5% year-to-date through Feb. 7, it appears to be on the mend.
AIG is essentially four businesses: Chartis, Sun America, United Guaranty and International Lease Finance. Chartis, which encompasses AIGs consumer and commercial property and casualty business, generates two-thirds of its overall revenue. Sun America, through its life insurance and retirement services delivers another 25%, with aircraft leasing and mortgage insurance kicking in the remaining 9% of overall revenue.
AIG’s net income in the third quarter was $1.9 billion, almost $5 billion higher than in Q3 2011. Things have improved dramatically on the top and bottom lines. I won’t go into too much more detail except to say that it’s a far simpler company with a much greater emphasis on its roots.
In a recent Bloomberg TV appearance, Berkowitz reckoned that his top holdings will increase 400% over the next five to seven years because they are still incredibly cheap. Further, he argues that with AIG’s price-to-book ratio at 0.56 or half that of competitors like Travelers (NYSE:TRV), once AIG management boosts return on owner’s equity to 10% (up from the current 5%), the annual return on investment will be 20%, providing great upside potential for those who buy at current prices.
A good money manager always leaves dry powder in the arsenal. At the Fairholme Fund’s Nov. 30 year-end, it had $1.5 billion in cash and equivalents or about 20% of the fund’s assets. On Jan. 28, it announced that it had sold its 40.6 million warrants in General Growth Properties (NYSE:GGP) back to the company for approximately $501 million. Given it’s closing the fund to new investors as of Feb. 28, the additional cash will come in handy.
Whether Berkowitz chooses to add to one or more of its existing positions — or more likely, to accumulate into something new — the next year will certainly be interesting for FAIRX investors. It’s not the highest cash position in recent years, but it’s up there. With General Growth out of the picture, cash represents about 29% of its total assets, and the top five holdings move from almost 80% down to 73% of assets.
With the exception of Sears Holdings (NASDAQ:SHLD) — which Berkowitz owns specifically because of the real estate play — I really like the fund’s concentrated holdings. It’s much easier to follow five or 10 stocks than 100 or more.
Whether you own the fund itself or the stocks within, you should do just fine in the years ahead.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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