VII332

ValueInvestor
February 29, 2012
The Leading Authority on Value Investing
INSIGHT
F E AT U R E S
Art and Science

Nearly everyone today claims a global approach, but Sarah Ketterer has been investing that way with considerable success for more than 20 years.
Inside this Issue

Investor Insight: Sarah Ketterer Scouring the developed world for bargains and finding them in Tesco, Western Union, Babcock & Wilcox and Tecnicas Reunidas. PAGE 1 Investor Insight: Jay Bowen On the prowl for prime beneficiaries of key global trends, which today include DuPont, Xylem, Canadian Pacific and Teck Resources. PAGE 1 A Fresh Look: WellPoint As the companys business prospects and performance have evolved over the past year, so has Jed Nussdorfs PAGE 16 opinion of its stock. Sarah Ketterer Causeway Capital Management Investment Focus: Seeks companies for which actual growth opportunities far exceed the myopic investor expectations currently built into the share price. Strategy: Seth Klarman Insight from an investing legend on how right-thinking investors can best manage through today's dangerous PAGE 17 state of affairs.
INVESTMENT HIGHLIGHTS INVESTMENT SNAPSHOTS
Babcock & Wilcox Canadian Pacific Railway
arah Ketterer has a simple answer for why stocks in today's hyper-competitive investing world can still, reliably enough, become attractively cheap: Nobody's patient anymore, she says. Ketterer's calm in the face of market storms has served her investors well. Her Causeway Capital Management now manages $13 billion in assets and its global value equity strategy has earned a net annualized 10.5% since inception in 2001, vs. 5.4% for the MSCI World index. Combining quantitative stock screens with detailed company research, Ketterer and co-founder Harry Hartford are uncovering bargains today in such diverse areas as money-transfer services, grocery stores, emerging-market capital spending and See page 2 energy infrastructure.
INVESTOR INSIGHT
Seeing the Forest

Top-down investing is more in fashion since the financial crisis, but Jay Bowen and his father before him have been successfully using that strategy since 1972.
INVESTOR INSIGHT
PAGE 8 11 14 12 7 6 16 5 13
Jay Bowen Bowen, Hanes & Co. Investment Focus: Seeks companies with the most attractively priced stocks in industries poised to benefit from what he considers key global economic trends.
ad his father's investment company not employed a big-picture approach to identifying attractive stocks, Jay Bowen, armed with an English Literature degree, probably would have looked elsewhere for work in 1986. I'll admit a bottom-up, number-crunching approach probably wasn't for me, he says. The fit has turned out wonderfully for Bowen, Hanes & Co. investors. The firm now manages $2.3 billion and its longestlived equity portfolio has generated a compound annual return of 14.9% since 1974, vs. 11.8% for the S&P 500. Keying primarily on trends tied to economic globalization, energy and commodities, Bowen today is finding opportunity in such areas as chemicals, water infrastrucSee page 9 ture, coal and railroads.
www.valueinvestorinsight.com
DuPont Teck Resources Tecnicas Reunidas Tesco WellPoint Western Union Xylem
Other companies in this issue:

AXA, Bank of Nova Scotia, BNP Paribas, Canadian National Railway, Canadian Natural Resources, Colgate-Palmolive, Dresser-Rand, Harris Corp., JGC Corp., John Wiley & Sons, Kennametal, Molina Healthcare, Munich Re, Nokia, PepsiCo, PostNL, Procter & Gamble, Siemens, Teradata, Timken, TransCanada, Zurich Financial Services
I N V E S T O R I N S I G H T : Sarah Ketterer
Investor Insight: Sarah Ketterer

Sarah Ketterer and Harry Hartford of Causeway Capital describe how they invest differently in developed versus emerging markets, where they find the worst allocation of capital, how they risk-adjust their share-return expectations, and what they think the market is missing in Western Union, Tesco, Babcock & Wilcox and Tecnicas Reunidas.
How has international investing most changed since you started out more than 20 years ago? Sarah Ketterer: When I was setting up Hotchkis & Wileys international equity business in 1990, the most interesting opportunities were in taking advantage of the arbitrage between valuations that appeared more rational and well-recognized in the U.S. and those that were less so overseas. International stocks were just generally less efficiently priced than stocks in the U.S. That gap between the U.S. and nonU.S. developed markets has closed dramatically. One reason Causeway has evolved more into global developed-market strategies rather than international only is because the opportunity set has essentially become one. Money now moves so fluidly between markets that the historical differences between U.S. and non-U.S. markets no longer apply. What key inefficiencies remain for you to take advantage of? SK: The primary inefficiency is one of time frame. Especially in the past five years, with the frayed nerves of investors after the 2008 crisis and with the continued rise of hedge funds, ETFs and computerized trading, time frames have truncated. Our investment horizon is three years, give or take, which allows us to invest with no obvious catalyst other than mean reversion and a return to normalcy. That works when nobody is patient anymore. Harry Hartford: There are a few types of situations that typically attract us. It may be in businesses that are cyclical and outof-favor and the market in our estimation misprices the stock out of impatience or an unwillingness to accept that the cycle
February 29, 2012
will mean-revert. It may be in businesses where management has erred, say in overreaching with an acquisition, where we believe the damage ultimately to be incurred is far less than is currently priced into the stock. Often its just that investors move in herds and overinvest in one part of the market say technology, media and telecom stocks in the late 1990s leaving whole industries ignored and very cheap. In the past couple of years, for example, we have found opportunity in industrial companies often with businesses that are energy- or infrastructure-related. These are companies that typically have a heavy orientation to emerging markets in Latin America, Asia and the Middle East, but trade at modest European- or American-market prices. So a company like Siemens [SIE:GR], maybe because its domiciled in Europe, maybe because its had high-profile runins with the authorities over past bribes, maybe because investors consider it an unfocused conglomerate, trades at only 10x our earnings estimate two years out, when, in fact, we believe its geared itself to emerging-market transportation, energy and infrastructure capital spending and has the capacity to generate significant growth. Its well-managed, strongly focused on returns on capital, has a very underleveraged balance sheet and pays a 4% annual dividend yield. Thats the type of story we find interesting. How did you respond when investors dumped European stocks en masse last summer? SK: We made the bedrock assumption that the euro zone would remain intact, primarily because the cost of a breakup in our view would greatly exceed the cost of funding peripheral sovereign debt. So as investors fled European banks and
Sarah Ketterer
Not Far From the Tree

The daughter of prominent Los Angeles investor John Hotchkis, co-founder of Hotchkis & Wiley, Sarah Ketterer was less than enthused by her first up-close exposure to investment management. I spent one summer in college filing tearsheets at my father's firm, she says. It was so awful I swore I'd never go back. After an Economics degree from Stanford, an MBA from Dartmouth and spending five years in investment banking, Ketterer did go back in 1990 to lead Hotchkis & Wiley's initial foray into international equities. She held that position through the firms 1996 acquisition by Merrill Lynch, but decided in 2001 to partner with longtime colleague Harry Hartford to launch their own international money-management firm, Causeway Capital. I'm sure as a kid I had more exposure than most to the world of equities, but once I joined his firm my father made a point of letting me ascend on my own or hang myself, Ketterer says. I had plenty of people to talk to and books to read which were invaluable but given how rapidly foreign markets were evolving, the best way to learn early on was rolling up my sleeves and trying to figure it out for myself.
Value Investor Insight 2
insurance companies last summer, we focused primarily on positions we already held and stress-tested them for the worst barring the implosion of the euro zone including significant haircuts on Greek, Portuguese, Irish, Italian and Spanish debt. Not everything made the cut we got out of Italys Unicredit because we found the downside incalculable but when we concluded the remaining companies had the potential to survive in any type of apocalyptic scenario, as value investors we had to step up and buy more. That meant adding to positions in banks such as BNP Paribas [BNP:FP] and insurers such as AXA [CS:FP], Munich Re [MUV2:GR] and Zurich Financial Services [ZURN:VX]. We didnt bet the ranch on them, but we werent afraid of them either. As a point of reference, many of our competitors at the time were buying consumer staples companies. Were classic value investors in the sense that when share prices are low, we think risk is low as well. Most people can understand that in theory but dont believe it in practice and even act as if its heresy. Its actually when prices are rising and stocks are converging with our shareprice targets that we find risk far more uncomfortable. Describe your research process in pursuing ideas. HH: Our quantitative team runs a variety of value screens every week to identify companies that are cheap within their country or within their industry. That output is made available to the research team on Monday morning, which then goes about trying to validate if the stocks are really cheap or not. We always assign two people to look into each security and the goal of their fundamental research is to build a financial model that reflects the underlying revenue streams of the business, the underlying costs of generating those revenues, the underlying costs of sustaining those revenues through investments, and any demands on cash flow from financing, taxes and capital allocation. From
February 29, 2012
that model we build a valuation framework discounted cash flow, price to book, normalized P/E, etc. for the business that is independent of its geography and specific to the industry in which it operates. That allows us to establish a two-year price target for approximately 160 companies on which well have done detailed research at any given time. We use twoyear targets because we think beyond that
adjusted-return ranking and less to those further down the list. Thats usually subject to a maximum holding in any one security at the time of purchase of 5%. SK: One advantage of having this type of roadmap is that it constantly adjusts the risk-adjusted returns as share prices move. As the price goes up, the return expectation decreases and we adjust position sizes on a regular basis to reflect that. So while the stock of Molina Healthcare [MOH], which is a managedcare provider focused on Medicaid patients, was extremely attractive to us on a risk-adjusted basis last fall, as its price has more than doubled weve taken profits and cut the position back dramatically. If the stock continues to outperform, it will continue to move down the ranking a signal for us to sell until finally the stock has a zero weight in the portfolio. Youve historically steered relatively clear of Japan. Why? HH: We have been underweight Japanese equities since we started, which reflects our view that Japanese managers by and large have been horrible allocators of capital. CEOs seem to have a time frame that far exceeds even ours, or believe their employees are more prominent constituents than shareholders. While this type of mentality has changed considerably in Europe, its still a big problem for us in investing in Japan. We will find companies we like there, but they tend to be far more international than domestic. One position of ours today is in JGC Corp. [1963:JP], a leading specialist engineering company focused on oil refineries and liquid-natural-gas [LNG] plants, with nearly 80% of its revenues generated outside of Japan. It has an excellent balance sheet, benefits from growing worldwide demand for LNG, and has a competitive cost base off which to bid on large-scale projects. While management isnt entirely Western in its approach, were quite comfortable with its stewardship of shareholder capital.
ON INVESTING IN JAPAN: We have always been underweight Japan; Japanese managers by and large have been horrible allocators of capital.
youre getting further into the realm of speculation and have to start embedding assumptions that are much harder to justify. We risk-adjust the expected returns to our price targets, and use those riskadjusted returns as the road map to build portfolios that typically hold 50 or so securities in our global strategy and 60-70 in our international strategy. How do you risk-adjust the expected returns? HH: We have an internal risk model, which incorporates more than 80 factors that contribute to the return profile of a security over time, such as its industry, its country of domicile, its currency, the cyclicality of earnings, its valuation and the price momentum exhibited by the security over time. The model allows us to calibrate the expected volatility of any security as a member of the current portfolio, which is how we adjust the return expectation to our two-year price target. Our objective is to have a level of portfolio volatility at or below the benchmark, with return expectations that beat the benchmark. All else being equal, in a 50-stock global portfolio well be allocating more capital to the stocks at the top of the riskwww.valueinvestorinsight.com
All value investors risk getting caught in value traps. In what ways do you try to avoid those? SK: One general defense against value traps is to by and large avoid productcycle businesses. You can have faith that Nokia gets its act together in smartphones, or that Motorola returns to prominence in handsets, or that the latest device from Nintendo is a big hit, but we think thats very tricky. For a company caught in the headwind of a business cycle, we can make assumptions about recovery that we consider to be wellfounded. We believe were much less able to make similar assumptions about future product cycles. Were also leery of industries with excess capacity independent of the business cycle. Were being very careful today in the automobile industry, for example, where theres still a lot of excess capacity and stepped-up competition is coming from China and elsewhere in Asia. We will buy shares in a company like Toyota after it had its recall problems, but that was more a shorter-term valuation bet than one on the longer-term prosperity of the industry. Describe how youre thinking about PostNL [PNL:NA], which primarily delivers mail in the Netherlands, from a value-trap perspective? HH: There is a technological obsolescence aspect to the story, but the decline in the traditional mail business is very slow and the company has considerable flexibility in adjusting its cost base in response as that happens. On the other hand, parts of the business such as higher-margin parcel delivery are growing around 10% per year. We also believe considerable asset value, primarily in PostNL's roughly 30% ownership stake in express-delivery company TNT, creates a floor for the share price. SK: Last year the shares suffered less from operational concerns than from the sovereign-debt crisis forcing the company to divert money from dividends to add
February 29, 2012
money to its pension fund. We think the worst is over on that front and that a normalization in Dutch bond yields would cause a re-rating of PostNLs shares [which currently trade at just under 4.50]. Even getting to the valuation level of the two other listed mail companies in Europe, Austrian Post and Deutsche Post which both trade at almost twice the P/E multiple of PNL would result in a significant gain in the stock. You follow a different strategy for investing in emerging markets versus developed ones. Describe that. SK: We concluded that our value strategy is more suitable to the developed world,
Turning to some specific developed-world ideas, describe your investment thesis for Western Union [WU]? SK: This is one of the many U.S.-listed companies we own that is far more focused outside the U.S. Theyre in the global money-movement business, primarily from people who have left their home countries to seek economic opportunity elsewhere and are sending money back home to support their families. Its a secular-growth business: According to World Bank statistics, remittances sent to developing countries reached $440 billion in 2010, up from around $160 billion in 2002. Other than a small drop in 2009, theres been a strong upward trajectory the entire time. Western Union has some 475,000 agents around the world 70% of which are located in high-traffic post offices or banks, and 100,000 of which are in China and India to facilitate those types of transfers for a fee. So one basic driver of our interest is that this is an ideal way for our clients to get access to emergingmarket income growth. We also very much appreciate the strength of the franchise. The company is the clear market leader 4-5x bigger than its next-largest competitor, MoneyGram in an industry where size confers important advantages. The incremental cost of processing a new transaction is minimal, so the largest network has far lower costs on a unit basis, making it difficult for a competitor to start a price war. Western Union has also built an extensive and hard-to-replicate compliance and legal infrastructure to comply with a wide variety of local rules and regulations it spends more money on compliance every year than many competitors take in as revenues. As a result of its franchise, the company earns twice the operating margins of competitors and its return on capital is generally over 40%. Theres also still plenty of room to increase market share. The industry is still quite fragmented and the company is in the best position to lead its further consolidation. It also has much lower penetration in some geographic areas than is
ON EMERGING MARKETS: We want to exploit the entire universe of opportunities, not just the subset a value manager is able to find.
where investors reward undervaluation and where earnings growth doesnt need to be present to catalyze a re-rating. Thats in contrast to developing markets, where investors are looking much more for growth than value. For that reason weve chosen for emerging markets to follow a broadly diversified, quantitative strategy that invests in more than 100 stocks across key markets. HH: Emerging markets are undoubtedly less efficient, so a quantitative methodology meant to identify factors that indicate inefficiency should work better. Valuation is still the primary component we use, but we also include factors such as earnings growth and estimate revisions, as well as macro input such as balance of payments data and the slope of the yield curve in the country of origin. We want to exploit the entire universe of opportunities that exist in emerging markets, not just the subset that a value manager is able to find.
likely to remain the case. By Western Unions estimates the Asia-Pacific region, for example, accounts for around 19% of the global money-transfer market, but the region accounts for only 9% of the company's revenue. Why is the market not recognizing this story as you think it should? SK: The company isnt immune to troubles in the economy, whether during the global recession of a couple years ago or more recently in Europe. Economic weakness means fewer migrant workers and less money transferred per transacINVESTMENT SNAPSHOT
tion. Those types of things can impact quarterly earnings and the market can overreact. I think investors also are worried about threats to the sustainability of the business, whether from price wars, competitors going after agents, or competition from new technology like mobile payments. In general, we believe the company has a strong enough position that traditional competitors will have a very difficult time eroding its franchise. The biggest risk we cant eliminate is mobile payments, where people transfer money using their cellphone. We tend to believe that Western Union is likely to be part of
any viable solution offered on this front by telecom operators, but were watching it very closely. The shares, at a recent $17.80, have gone nowhere over the past three years. What potential do you see in them from here? SK: This is one of our top positions based on risk-adjusted return. Its not correlated with much of our current portfolio and trades at less than 10x our 2013 earnings estimate of $1.90 per share. The free cash flow yield is close to 10%. Assuming earnings growth in the midsingle-digit range and essentially stable margins, our DCF model gives us a twoyear price target of $33. That doesnt assume a recovery in the U.S. housing market, which would bring in more migrant construction workers who are heavy users of the companys services. All in all, the combination of strong shareprice upside and such a unique and defendable franchise makes this a very attractive stock for us to hold. Whats driving your interest in the U.K.s Tesco [TSCO:LN]. HH: Tesco is the dominant player in U.K. grocery retailing and has also expanded aggressively in international markets, including big presences in South Korea, Thailand, Malaysia, Hungary and Poland. It has modest market share in the western U.S. through a small-grocery concept called Fresh & Easy Neighborhood Market. This is a good example of what Sarah was talking about earlier with respect to investor time frames. The company recently announced that it was revamping its U.K. strategy, somewhat away from a single-minded emphasis on price and more toward offering better quality. A central thrust of that is an enhanced focus on fresh food how much of it there is, how its displayed and how often its replenished. Most of the investment behind this is going to take place through the fiscal year ending February 2013, so it caused analysts to pare back estimates for both this fiscal year and next. Consistent
Western Union
(NYSE: WU)
Valuation Metrics
(@2/28/12):
Business: Largest provider of moneytransfer services, executing nearly 20% of international remittances through a global network of some 475,000 agent locations. Share Information
(@2/28/12):
Trailing P/E Forward P/E Est.
WU 9.7 10.2
S&P 500 15.8 13.1
Largest Institutional Owners

(@12/31/11):
Price
52-Week Range Dividend Yield Market Cap
Financials (TTM):
17.78
14.55 22.03 2.2% $11.03 billion $5.49 billion 26.1% 21.2%
Company Wellington Mgmt T. Rowe Price Vanguard Group State Street BlackRock
Short Interest (as of 2/15/12):
% Owned 10.9% 6.2% 4.1% 3.7% 2.7% 2.4%

25
Revenue Operating Profit Margin Net Profit Margin

WU PRICE HISTORY 25
Shares Short/Float
20
20
15
15
10 2010 2011 2012
10
THE BOTTOM LINE
The market is mispricing the companys unique and defendable franchise in a secularly-growing global industry, says Sarah Ketterer. Assuming annual percentage earnings growth in the mid single digits and basically flat margins, her DCF model yields a twoyear share-price target of $33. If U.S. housing picks up, the upside would be greater.
Sources: Company reports, other publicly available information
February 29, 2012
with their focus on short-term earnings momentum above all else, investors abandoned the stock, causing it to fall nearly 25% in the span of a couple weeks last month. So the first element of our thesis is that the revamp in the U.K. represents a necessary investment that will more than justify its short-term cost. On top of that, we see tremendous latent earnings-growth potential on the international side of the business. Non-U.K. operations account for roughly 40% of total revenues today, but only about 20% of total profits. Thats not surprising given that these are faster-growing investment markets for Tesco, but as these businesses mature they will account not only for a higher share of the total, but will also operate at higher margins than they do today. That type of
INVESTMENT SNAPSHOT
operating leverage should work its way nicely through the income statement in future years. How inexpensive do you consider the shares at todays price of around 3.20? HH: The shares trade at less than 8.4x our February 2014 earnings estimate of 38 pence per share. At about 25 billion, the invested capital in the business mostly real estate approximates the current market cap, meaning the present value of the companys cash flows are barely being valued. We think were being conservative in using an 11x multiple on our fiscal 2014 earnings estimate to arrive at a two-year price target of nearly 4.20. We dont consider that a big stretch, given that the
stock spent much of the past year at or near that level. SK: Id add that the dividend yield here of 5.1% makes this a particularly appealing value stock. Even if it takes longer than expected to realize the earnings improvement, the healthy balance sheet means we face little financial risk and were still getting the dividend. We think its just a question of time for this to pay off. If were early, so what? You appear to have a like-minded shareholder in Warren Buffetts Berkshire Hathaway, which has a roughly 5% stake in Tesco. HH: We always say its nice to be in good company. Describe the unrecognized value you see in Spains Tecnicas Reunidas [TRE:SM]. HH: Tecnicas is an international general contractor, mostly active in the engineering, design and construction of industrial facilities for energy and power-generation markets. Its domiciled in Spain, but the Spanish market represents only 5% of its order backlog. Overall, 37% of the backlog comes from the Middle East, 20% from Latin America and 20% from Europe (including Spain). Competitors would include companies like Jacobs Engineering and Fluor from the U.S., Technip from France and Hyundai Heavy Industries from South Korea. How does Tecnicas distinguish itself competitively? HH: Theres a sizable family ownership more than 30% and a byproduct of that is that the company is very risk-conscious in bidding for major long-term contracts. That means its unlikely to be hurt by the overly aggressive deal that can weigh for a long time on companies in this type of business. At the same time, Tecnicas is known for its ability to deliver very large turnkey projects on time and within budget. As you might expect, that means a lot in this business.
Tesco
(London: TSCO:LN)
Business: U.K.-based grocery retailer operating roughly 5,000 stores in 14 countries located in Western Europe, Eastern Europe, Asia and the United States. Share Information
(@2/28/12, Exchange Rate: $1 = 0.63):
Financials (FY2011):
Revenue Operating Margin Net Profit Margin

Valuation Metrics
(Current Price vs. TTM):
60.93 billion 6.3% 4.4%
Price
TSCO PRICE HISTORY 4.50 4.00 3.50 3.00 2.50
3.18 3.11 4.23 5.1% 25.49 billion
P/E
TSCO 8.8
S&P 500 15.8
4.50 4.00 3.50 3.00 2.50
2010
2011
2012
THE BOTTOM LINE
Operating leverage as a needed U.K. store-investment program winds down and as international operations mature should work its way nicely through the companys income statement in future years, says Harry Hartford. At 11x his earnings estimate for the year ending in February 2014, the shares two years out would trade at 4.20.
February 29, 2012
INVESTMENT SNAPSHOT
Tecnicas Reunidas
(Madrid: TRE:SM)
This is another case where the dividend yield of 4.4% is a big plus. As with Tesco, were being paid to wait for the valuation to improve as we think it will.
Financials (9 mo. ending 9/30/11, annualized):
Business: International general contractor specializing in the engineering, design and construction of industrial facilities for the onshore production of oil and gas. Share Information
(@2/28/12, Exchange Rate: $1 = 0.74):
Revenue EBIT Margin Net Profit Margin

Valuation Metrics
(Current Price vs. TTM):
2.66 billion 5.8% 5.0%
Back on this side of the pond, why do you believe Babcock & Wilcox [BWC] is mispriced? SK: This is a unique company, which was spun out of oil-services firm McDermott International in August 2010. Its primary businesses are in supplying and servicing nuclear components for the U.S. Navys nuclear submarines and aircraft carriers accounting for roughly 60% of total revenues and in building, maintaining and retrofitting the coal boilers that generate steam in utility power plants. Its a more domestic business than many we own, with about 80% of revenues generated in the United States. The most exciting part of the business is in meeting capital-spending demand from utilities to retrofit coal-burning plants to meet stricter environmental regulations. That addressable market has been estimated at between $12 and $24 billion over the next five years. Given that Babcocks market cap is only $3 billion, getting even a modest share of that new business can make a huge difference to the bottom line. We assume the market is concerned about the high reliance on military spending. Are you? SK: Given the growth expected in the utility business, the backlog tied to military spending is closer to 40% of the total, rather than the 60% share it has of current revenues. While we dont expect this business to grow rapidly, we actually see upside for Babcock as it rolls out additional components for the submarine and aircraft-carrier programs it currently supplies. So rather than providing 10% of the componentry in a nuclear sub, say, they believe they can take that to 20% or even 30%. If theyre successful, even if the pie shrinks somewhat which we dont really expect to be the case theyll compensate by taking a bigger slice.
Price
TRE PRICE HISTORY 50
30.58 21.50 43.74 4.4% 1.69 billion
P/E
TRE 12.5
Russell 2000 41.3
50
40
40
30
30
20
2010
2011
2012
20
THE BOTTOM LINE
Given its risk-averse management, rock-solid balance sheet and reputation for on-time and on-budget project delivery, the company is well-positioned to benefit from high global demand for energy-related infrastructure, says Harry Hartford. At 13x his 2014 earnings estimate, after accounting for net cash, the shares would trade at 51.
Is a big part of the bet here on increasing demand for energy infrastructure? SK: This is not the only company we own in this general area. As long as energy demand is increasing a safe bet given the continued rise of newly industrialized countries we expect capital expenditures required for the exploration, production, processing and transport of oil and gas to continue to grow. That overall growth is an important part of our investment thesis. HH: Many natural-resource-rich countries in the past didnt do much with those resources other than take them out of the ground and ship them off. Over the past 10 years or so there has been a concerted effort on the part of countries, particularFebruary 29, 2012
ly in the Middle East, to extract additional value-added from their resources through some level of processing. That trend isnt going away and is something Technicas is positioned to exploit. How attractive do you consider the shares at a recent price of 30.60? HH: This is a project business, so the stock often trades more on short-term order flows than on the underlying strength of the business. Were estimating 2014 earnings at around 2.90 per share and believe a normalized multiple for a business with this type of growth profile, profitability and financial strength is around 13x. After accounting for more than 12 per share in net cash, our twoyear price target is 51 per share.
HH: One important thing to note about this defense franchise is that the maintenance of the nuclear-submarine fleet and installation of new equipment is only ever going to be done by an American company, and Babcock has a virtual lock on the business. That adds considerably in our view to the stability of the business going forward. Weve seen much discussion of the companys mPower nuclear-reactor technology. What are its prospects? SK: We arent putting a value on it because its not completely through
INVESTMENT SNAPSHOT
research and development, but it is certainly a promising technology that could have huge demand. Its a small mobile nuclear module for power generation, which allows for adding capacity in smaller increments to meet load-growth projections and has the potential to provide a safer, more contained nuclear-generation process. Its too early to say its a game-changer, but it does provide a nice call option on the upside. After falling for much of last year, the shares have recovered somewhat to a recent $26.10. What upside do you see from here?
SK: Making what we believe are conservative assumptions for the utility business to grow at only GDP plus 1% and for the military business and margins overall to be relatively stable, we arrive at a discounted-cash-flow value two years out of nearly $41. The balance sheet has net cash and while theres no dividend yet in this case, its certainly not beyond the realm of possibility that theyll institute one. The most problematic risk would be a wholesale pullback from current required environmental regulations, so that utilities wouldnt have to spend as much with Babcock on retrofitting their plants. We consider that extremely unlikely, but it is a risk. What on the macroeconomic front do you think investors may not be worried enough about today? SK: One concern we always have but that is especially relevant in todays environment is protectionism. Countries facing difficult times can increasingly turn to political demagogues whose answer is to close borders and shun international trade. Those taking that road will become pariahs in the global debt markets, and any exposure we have in those areas or to companies that rely on trade with them would be at severe risk. Are you of the mind that the market volatility weve had over the past few years is just something well have to get used to? SK: I look at the 2008 global financial crisis as a generational event, which followed a long period of credit creation that had to come to an end. I'm not surprised that 2009 did not mark the end of the crisis, and aftershocks have occurred in heavily-indebted Europe. But these are all phases, and volatility will return to long-term averages. For now, however, were able to find very profitable investments by taking advantage of short-termism and of the masses of investors with no more than a goldfishs memory of past market cycles. VII
Babcock & Wilcox

(NYSE: BWC)
Valuation Metrics
(@2/28/12):
Business: Manufacture and servicing of utility, industrial and military power-generation systems that utilize nuclear, fossil-fuel and renewable energy sources. Share Information
(@2/28/12):
BWC 19.5 15.1
S&P 500 15.8 13.1

(@12/31/11):
Price
Financials (TTM):
26.06
18.05 36.02 0.0% $3.07 billion $2.86 billion 4.7% 5.5%
Company T. Rowe Price Mason Capital Primecap Mgmt Shapiro Capital Vanguard Group
% Owned 17.7% 12.0% 8.0% 5.3% 3.9% 0.7%

40 35 30 25 20 15

BWC PRICE HISTORY 40 35 30 25 20 15
Shares Short/Float
2010
2011
2012
THE BOTTOM LINE
Overshadowed by its larger division serving the U.S. military, the companys utilityrelated business is poised to grow rapidly due to demand for plant retrofits to meet stricter environmental regulations, says Sarah Ketterer. Based on her discountedcash-flow analysis, the two-year price target for companys shares is nearly $41.
February 29, 2012
I N V E S T O R I N S I G H T : Jay Bowen
Investor Insight: Jay Bowen

Bowen, Hanes & Co.s Jay Bowen explains why hes particularly enamored with stocks in Canada, what companies he expects to benefit from an industrial renaissance in the U.S., the development that would dampen much of his long-term optimism, and why he believes Canadian Pacific Railway, Teck Resources, Xylem and DuPont are mispriced.
Your strategy is driven more by the analysis of big-picture themes than companyby-company specifics. Why? Jay Bowen: The firm since my father started it in 1972 has always taken a topdown approach. We begin with a broad analysis of global macroeconomic, political and technological trends, the objective being to determine how these trends will impact specific industries and companies. Our view is that if we can get in front of big trends and position our portfolios in sectors with the most secular growth potential, were better setting ourselves up to add long-term value. There are plenty of ways to invest successfully ours is not the only way and it certainly isnt always successful, but its worked for us over a long period of time. Give an example showing how you move from the top on down in your analysis. JB: There are typically several pieces to the puzzle. Were very focused today on Canada, for example, based on a variety of political and economic trends. The government is pursuing economic reforms that we believe will keep it on a path with higher growth, lower unemployment and a stronger currency than will be possible in the U.S. Theyre cutting corporate taxes, reducing federal debt as a percentage of GDP and consistently moving higher on country rankings of economic freedom. With that favorable economic-policy backdrop, Canadas abundant resources and best-in-class companies serving global commodities markets also make it ideally suited to benefit from growing secular demand for natural resources in an industrializing world. Once weve made these types of broad conclusions, its then a question of finding the best ways to play them. For us today that translates
February 29, 2012
into holdings in commodity producers, such as Teck Resources [TCK] in coal, copper and zinc and Canadian Natural Resources [CNQ] in oil and natural gas. It means holding railroads like Canadian Pacific Railway [CP] and Canadian National Railway [CNI], and pipeline companies like TransCanada [TRP]. It even supports our position in Bank of Nova Scotia [BNS], one of our few financial holdings, which has the tailwinds of being in Canada without the regulatory headwinds that U.S. banks face and which we fear could turn them more into utilities than thriving business enterprises. Once focused on an industry, how do you select individual companies to own? JB: Our top-down work is meant to uncover not just absolute trends, but those which we also believe will happen faster or with greater magnitude than anticipated. For that reason we generally expect the companies in a given target industry to perform better from a growth and profitability standpoint than what appears to be priced into the stocks. So in many ways picking individual stocks at that point turns for us into an in-depth relative-valuation analysis. If we get the asset class right, the country right, the sector right and the industry right, we believe were really at least 90% of the way there. The truth is that if were interested in Deere [DE] and Caterpillar [CAT] each of which we own theres a good chance both are going to do pretty well. When choices have to be made, we go with the better value. While we certainly dont have a blackbox approach to stock selection, were typically buying companies that have P/Es based on our forward earnings estimates that are below the market, earnings growth rates based on our estimates that are above the market, current dividend
Jay Bowen
Compounding Power
Two years after Jay Bowen's father, Harold, co-founded Bowen, Hanes & Co., the firm landed a prized client, the Tampa, Florida Pension Fund for Firefighters and Police Officers. The pension fund invested $12.1 million on September 30, 1974, starting a remarkable long-term relationship that provides an object lesson in the power of compound returns. Tampa's portfolio consists of both stocks and bonds, although Jay Bowen, now CEO of the firm, says the fixed income portion is managed mostly for income and stability, so has more or less matched its benchmarks. The overall portfolio's outperformance, then, is due primarily to the fact that over more than 37 years it has earned on common stocks 3.1% per year more than the S&P 500, 14.9% vs. 11.8%. The bottom-line result of that outperformance? Even after more than $600 million in net withdrawals, Tampa's assets with Bowen, Hanes have increased to more than $1.5 billion. The 3.1% per year alpha in common stocks has resulted in 2.75 times more money from equities than would have been generated by investing in the market index. Not a bad way to build a long-term client relationship.
yields and 10-year dividend growth rates that are above the market, and foreign revenues that are at least 50% of the total, with an emphasis on emerging rather than developed markets. Is the dividend emphasis relatively new? JB: We have been paying much more attention to dividends over the last couple of years. In this interest-rate environment, where consistent dividend payers are yielding more than government and corporate bonds, the demand for higheryield stocks should continue to go up from investors looking for income. The long-term record for dividend payers is impressive: One study from last year found that from 1972 to 2011, when the S&P 500 returned 6.8% per year, shares of companies that didnt pay dividends returned 1.2% annually, while those that initiated or grew dividends over that period returned 9.1%. We think were in a period in which the share of total return coming from dividends is likely to revisit the high levels of the 1950s and 1960s. Youve made the case for a multi-year industrial renaissance in the U.S. Describe that. JB: One of the most important trends were looking at is our belief, triggered by the shale-energy revolution, that over the next ten years its possible that the U.S. overtakes Russia and Saudi Arabia to become the worlds top oil and gas producer. That would have a significant impact on our entire manufacturing base, as a result of lower energy input costs and the heightened activity around the development, production and transportation of all the oil and gas. The tentacles are long with something like this. The CEO of Nucor, the steelmaker, is talking about building lower-cost natural-gas-powered plants that can produce the same amount of steel with about one-quarter of the capital needed for a traditional coal-powered plant. You have lower production costs, lower input costs, savings for the customer and less emissions, making it a win-win for jobs, industry and the environment. In places like
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Ohio, investors have committed $2 billion to shale operations in the state and the French company Vallourec is spending several hundred million dollars to build production capacity for pipeline infrastructure. Those types of investments can transform a struggling Rustbelt state, and play out over and over again elsewhere. What companies do you consider particularly poised to benefit? JB: Some of the Canadian firms I mentioned earlier, including TransCanada and the railroads, would be big beneficiaries. As would companies like Dresser-Rand [DRC], which manufactures and services equipment that is primarily used in the
Given that we usually have high cyclical exposure, that defensive component has helped us over the years. Every single holding isnt going to tie into a global, thematic trend. For example, we own John Wiley & Sons [JW/A], the book publisher, for no other reason than its been a solidly growing niche company that has consistently delivered over the years and is attractively valued. Were not overly active in technology, but weve done very well with Teradata [TDC], which has a variety of proprietary enterprise computing solutions that we think provide a long-term play on cloud computing. In this case, we also believe it could prove to be an interesting takeover candidate, so its somewhat of a special situation in that regard. Do you have any portfolio rules or guidelines on things like position sizing or industry weighting? JB: We really dont. On individual position sizes, our core positions at cost tend to be of relatively comparable weight we dont try to distinguish that one idea is 20% better than another so we should have 20% more of it. As for industry and sector weightings, we are aware of the level of exposure we have, but have rarely found it necessary to pull back in any one area because we considered ourselves over-exposed. One thing we do pay attention to is an individual position becoming too large. If a stock gets beyond 5% or so of the portfolio, well usually take some profits and scale it back. Elaborate more specifically on why you find Canadian Pacific Railway to be so compelling. JB: Railroads have been an important part of our portfolios for years and this one fits nicely into any number of powerful topdown themes. With direct links to eight different ports in the U.S. and Canada, including Vancouver and Montreal, Canadian Pacific benefits directly from continued expansion in global trade. It plays a key role in the energy supply chain in Canada and the northern U.S., serving key resource areas such as the Bakken forValue Investor Insight 10
ON U.S. RENAISSANCE: Within ten years its possible the U.S. overtakes Russia and Saudi Arabia as the worlds top oil and gas producer.
exploration, production, processing and transportation of oil and natural gas. Even though their stocks have been fairly strong lately, we also still like the longterm prospects of machinery and equipment companies like Kennametal [KMT], which makes a variety of tooling and engineered products used in industrial production, and Timken [TKR], which makes bearings and related products used by original-equipment manufacturers. You own several consumer packagedgoods companies. Whats the thematic element there? JB: Weve always had a solid representation in consumer-products and food companies, such as PepsiCo [PEP], ColgatePalmolive [CL] and Procter & Gamble [PG]. Part of that is our view that they will incrementally benefit from the more rapid economic growth in developing markets, but we also like that they pay healthy and growing dividends and provide a cushion to the portfolio during sharp downturns.
mation, Marcellus shale, Alberta oil sands and major ethanol production areas in the U.S. Midwest. It is a big player in soft commodities such as grain and fertilizer, serving the expanding global agricultural trade. Also, after heavy investments in infrastructure, the company has a major presence in intermodal shipping, which has increasingly become an efficient and cost-effective option for more and more companies. From an industry perspective, we expect the operating leverage and pricing power exhibited by railroads in recent years to continue. That is especially true if high oil and gasoline prices persist, which
INVESTMENT SNAPSHOT
enhances the cost-efficiency argument for railroads over truckers. We even consider railroads an attractive inflation hedge, given how theyd benefit from growth in demand and prices for natural resources. What makes this particularly interesting is the potential here for an operating turnaround. Canadian Pacific under its existing management has long been a performance laggard relative to its primary competitor, Canadian National Railway, which has been a core holding of ours for many years. That underperformance has prompted a proxy fight by Bill Ackman of Pershing Square Capital, who wants to install five new board members as well as
a new chief executive, Hunter Harrison, who is a former CEO of Canadian National. Canadian Pacific shareholders are scheduled to vote on Ackman's nominees at the annual meeting in May. We take it youre not backing current management. JB: Theres a compelling case for change and we think the company is going to lose the proxy battle. Hunter Harrison says theres no reason Canadian Pacific cant move its operating ratio [operating expenses divided by net sales] from a current level of 78% to closer to the 65% Canadian National realized while he was running it. Thats a realistic five-year goal and Harrison is ideally suited to lead the turnaround you dont have to speculate about whether he can pull it off because hes done it before. The shares have rallied since Pershing Squares entry into the picture and now trade at $75.25. What upside do you see from here? JB: We assume that over the next five years revenue can grow by around 6% annually. If the proposed operating-ratio goal is met, that would translate into around $10 in per share earnings five years out. At a reasonable 14x multiple, that would get us close to a double in the share price. The lower operating ratio would also give the company more cash to reinvest in the business or return to shareholders in the form of dividends the current yield is 1.6% or share buybacks. That would be another plus if they can pull it off. Staying in Canada, whats driving your interest in Teck Resources [TCK]. JB: We spoke earlier about our bullishness on global commodity demand, which will benefit Teck as a major producer of coal, copper and zinc. The more specific driver of our interest, however, is coal, which accounts for 50% of the companys revenues and which we believe is poised for a period of significant growth.
Canadian Pacific Railway

(NYSE: CP)
Valuation Metrics
(@2/28/12):
Business: Class I railroad operator hauling shipments primarily of intermodal containers, grain, coal and fertilizer in Canada, the U.S. Midwest and the U.S. Northeast. Share Information
(@2/28/12):

(@12/31/11):
CP 22.5 17.6
S&P 500 15.8 13.1
Price
Financials (TTM):
75.26
44.74 77.55 1.6% $12.79 billion $5.18 billion 18.7% 11.0%
Company Pershing Square Capital Artisan Partners Wentworth, Hauser & Violich Royal Bank of Canada BMO Capital
% Owned 14.2% 5.1% 4.4% 3.9% 3.0% n/a

80 70 60 50 40 30 20

CP PRICE HISTORY 80 70 60 50 40 30 20 2010
Shares Short/Float
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THE BOTTOM LINE
Jay Bowen believes the company is not only well-suited to capitalize on several key economic trends, but is also ripe for an operating turnaround currently being instigated by Pershing Square Capital. Assuming 6% annual revenue growth and that proposed margin goals are met, he believes the shares can reach $140 within five years.
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What really caught our attention was last Decembers United Nations conference in South Africa on climate change, which couldnt agree on a replacement for the existing Kyoto Protocol agreement that will remain in place until 2020. That means theres no binding long-term global agreement limiting greenhouse gas emissions, which we consider a bullish scenario for coal producers. Another key point is that the Chinese domestic coal industry has been unable to keep pace with surging demand from its steel industry for metallurgical coal. For the country to achieve an efficient, stable coal-based infrastructure, it is going to
INVESTMENT SNAPSHOT
have to rely on significant imports over the next several years. While Australian coal miners will be obvious beneficiaries, we believe demand will be high enough for Teck already the second-largest exporter of metallurgical coal in the world to benefit as well. It has the capacity to significantly increase its annual output of metallurgical coal and can do so at relatively low capital cost. It doesnt hurt its prospects in China that the companys largest shareholder, following a 2009 forced recapitalization, is the sovereign wealth fund China Investment Corp. On the thermal-coal side, all our analysis points to strong global demand
as new coal-fired electricity generating capacity is installed worldwide over the next several years. Were keeping a particularly close eye on Japan, which is expected to move sharply away from nuclear power following last years Fukushima disaster. That will likely lead to significant import demand from Japan for coal. Is anything particular of note going on elsewhere in the company? JB: Demand for both copper and zinc should primarily benefit from expanding GDP growth in emerging markets. Copper probably offers the most potential for revenue growth, as the company has several advanced-stage projects entering production over the next five years. Another kicker, which is not a generator of revenues or profits today, is Tecks Frontier oil-sands asset located in the Athabasca region of northeastern Alberta. They recently bought out their partner on the project and appear very committed to bringing it on line. Its all quite speculative at this point, but if it happens at anywhere near the scale projected, it could account for a meaningful portion of the companys market value within the next ten years. Trading at around $41, how inexpensive are the shares?
Teck Resources
(NYSE: TCK)
Valuation Metrics
(@2/28/12):
Business: Diversified mining company focused on commodities such as coal, zinc, copper and lead, with primary operations in Canada, the United States, Chile and Peru. Share Information
(@2/28/12):

(@12/31/11):
TCK 9.1 10.2
S&P 500 15.8 13.1
Price
Financials (TTM):
41.06
25.76 59.75 1.9% $24.06 billion $11.53 billion 37.0% 23.2%
Company China Inv Corp BlackRock RBC Global I.G. Inv Mgmt TD Asset Mgmt
% Owned 17.5% 8.9% 3.7% 2.2% 2.2% n/a

80 70 60 50 40 30 20 10

TCK PRICE HISTORY 80 70 60 50 40 30 20 10 0
Shares Short/Float
2010
2011
2012
THE BOTTOM LINE
While company earnings may be volatile, Jay Bowen expects them to grow at a low- to mid-teens annual rate over the next five years, primarily driven by strong global demand for coal and expanded copper production. Applying a 10x multiple to his estimate of $7-8 in EPS within five years, the shares would increase 75-100% over that time.
JB: Earnings are likely to be volatile, but we believe with all the secular tailwinds can increase at a low- to mid-teens annual rate over the next five years. That would result in $7 to $8 per share in earnings, which at even a 10x multiple would result in close to 100% appreciation from todays price. This has not been a stock for the faint of heart, but one big positive is that the company has significantly repaired its balance sheet through asset sales and by raising equity over the past three years. Long-term debt is now something like 25% of total capital. That allows us to more confidently focus on long-term supply and demand trends that we expect to work very much in the companys favor.
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Water is a commodity you havent yet mentioned. How is it driving your interest in Xylem [XYL]? JB: Xylem is one of three businesses that ITT Corp. broke itself into last October. We had been long-term shareholders in ITT and Xylem was the only piece we decided to keep it is the highest-quality asset and the most interesting from a thematic standpoint. The company provides a full spectrum of products for the transportation, treatment and testing of water, serving publicutility, industrial, commercial, residential and agricultural markets. It operates in a large, fragmented global industry in which big conglomerates tend to be involved, including GE, Siemens and Pentair. Xylem is the largest pure play, but while 65% of its revenues come from overseas, it currently is only available to service maybe 10% of the nearly $300 billion global market for water equipment and services. That gives an indication of the potential we see for it. What water-related themes do you consider tailwinds here? JB: In developed markets, demand is largely driven by the need to replace crumbling infrastructure, the need for enhanced pump systems to move water from more distant sources, and the need for more sophisticated testing and filtration systems to meet environmental regulations. To give one example, there are estimates out there that 60% of the U.S. water infrastructure should be replaced in the next ten years, at an estimated cost of approximately $1 trillion. In emerging markets, more rapid growth is driven by infrastructure spending required by increased urbanization and by the general need for enhanced water systems for industrial, commercial and residential users as economies grow and populations expand. U.S. water demand tripled in the last 30 years, while the population grew only 50%. As a similar dynamic plays out in China which has 21% of the worlds population but only 7% of its fresh water you can see
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how ready access to water is an ongoing problem that solutions providers like Xylem will be tasked to address. Beyond purely economic demand, there is also significant need from a public-health perspective to enhance cleanwater availability. More than one billion people today live without decent access to clean water, making death by treatable water-borne diseases one of the scourges of the third world. Were not holding out Xylem or others in the industry as having answers to all these problems, but its clear to us that their ability to provide technologies and solutions to make things better will be in high demand.
INVESTMENT SNAPSHOT
The shares, at $26.85, are up nearly 15% since the spinoff. How are you looking at valuation today? JB: Driven by both strong top-line growth and margin expansion from operating leverage, we believe the company has a good chance to compound earnings at a low double-digit rate over the next five years, to around $3 per share. Put a normal market multiple on that and the stock would trade in the mid-$40s. While thats not an eye-popping prospective return, wed expect it to outperform the market and also see potential catalysts on the upside. One would be
Xylem
(NYSE: XYL)
Valuation Metrics
(@2/28/12):
Business: Recent spinoff from ITT Corp. offering a broad spectrum of products and services supporting the transportation, treatment and testing of water worldwide. Share Information
(@2/28/12):

(@12/31/11):
XYL 15.3 12.7
S&P 500 15.8 13.1
Price
Financials (TTM):
26.84
22.67 28.28 1.5% $4.95 billion $3.74 billion 13.0% 8.7%
Company Barrow, Hanley, Mewhinney & Strauss Vanguard Group State Street BlackRock T. Rowe Price
% Owned 7.0% 5.2% 3.6% 3.0% 2.3% 2.7%

30

XYL PRICE HISTORY 30
Shares Short/Float
25
25
20 2010 2011 2012
20
THE BOTTOM LINE
Its sole focus on water-related equipment and services positions the company to benefit from significant demand drivers in both developed and emerging markets, says Jay Bowen. Putting a market multiple on his EPS estimate five years out, the shares would trade in the mid-$40s. A naturally higher profile would provide added upside, he says.
from multiple expansion as the earnings numbers come in and the stock generates more institutional interest on Wall Street. Since the spinoff Xylem has had a very low profile we typically like that when establishing a position, but we expect it to change as the company prospers. In addition, theres a very good chance that this fragmented global industry becomes less so as the leaders look to consolidate market share. Wed never own it for just this reason, but I cant help but think at some point Xylem would make a very attractive acquisition for a larger industrial company looking to expand its water business. Describe your investment case for DuPont [DD]. JB: We consider DuPont somewhat misunderstood. It operates in a variety of traditional chemicals businesses tied to construction, electronics and plastics, but what attracts us is that 75% of its capital and R&D expenditures are allocated to segments that we believe have very strong growth prospects. Its evolving more into a high-tech science company and away from a cyclical chemical company. At a broad level, its geared nicely to global economic growth, with operations in 80 countries, 60% of revenues coming from outside the U.S., and 35% of revenues specifically in emerging markets. While its getting out of businesses like car paint which could bring in more than $4 billion in a sale it continues to expand in strong secular-growth businesses like agricultural commodities and alternative energy. The agriculture business provides hybrid corn and soybean seeds under the Pioneer brand name and also sells herbicides, fungicides and insecticides. Global food demand is estimated to increase 70% by 2050, with an increasing percentage of calories consumed globally coming from corn- and grain-fed animal products. Given that the amount of unfarmed arable land around the world is limited, the only way to meet that increased demand is through improving crop yields on existing farms, which is what Pioneer
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is all about. Its the oldest and largest seed company, has been capturing market share from competitors on a consistent basis since 2008, and has a strong pipeline of new products coming out over the next few years. Another key growth area for DuPont is providing materials and systems for photovoltaic products used in the solar industry. It has key strategic relationships with many of the top industry manufacturers and has been an innovator in helping advance solar-module performance. Management has set a goal of $2 billion in sales into the photovoltaic market by 2014, up from $1.4 billion today, and we
INVESTMENT SNAPSHOT
think thats reasonable given the still-rapid growth in solar installations globally. There are other areas with energy, environmental, nutrition and health applications that have intense R&D and acquisition support. As these markets expand, innovations are commercialized and acquisitions assimilated, we see potential for significant incremental returns. How does all that translate into upside for the stock, now at around $51.40? JB: We believe the company can increase earnings per share to $6.50 to $7 over the next five years, which would result in
DuPont
(NYSE: DD)
Valuation Metrics
(@2/28/12):
Business: Global chemicals producer serving markets including agriculture, nutrition, electronics, communications, construction, transportation and apparel. Share Information
(@2/28/12):

(@12/31/11):
DD 14.0 12.0
S&P 500 15.8 13.1
Price
Financials (TTM):
51.39
37.10 57.00 3.2% $47.91 billion $38.44 billion 12.8% 9.0%
Company State Street Capital World Inv Vanguard Group BlackRock JPMorgan Chase
% Owned 4.5% 4.0% 4.0% 2.5% 2.4% 1.3%

60 50 40 30 20 10

DD PRICE HISTORY 60 50 40 30 20 10
Shares Short/Float
2010
2011
2012
THE BOTTOM LINE
The companys evolution beyond its cyclical industrial-chemical roots is not well recognized by the market, says Jay Bowen. Bolstered by growth in such areas as agriculture, alternative energy, health and nutrition, he believes earnings can grow as much as 10% per year and that the shares within the next five years can reach at least $90.
above-average annual growth in the 910% range. At the same time, on consensus 2012 earnings estimates the stock is at only 12x earnings, less than the estimated 13x at which the S&P 500 trades. Put a 13-14x multiple on our longterm earnings projection, and the stock price would be around $90. On top of that, the shares now pay a 3.2% yield a 70% premium to the 10-year Treasury and the company has a history of increasing dividends at an above-market rate. When your thesis proves faulty, does it tend to be more of a problem with the company, or with the trend you were counting on. JB: Either can certainly happen. We had owned communications-equipment supplier Harris Corp. for many years, but concluded late last year that its revenues were more at risk from government spending cuts than we were comfortable with, and that management just didnt
have as solid and cohesive a business plan as we wanted. We also recently sold Nokia after concluding that while the valuation was seemingly interesting, we had been excessively enamored with the dividend yield and also underestimated the negative impact on margins and earnings from commoditization in the handset market. Can they innovate around that? Maybe, but it wasn't a bet we were willing to make. How did your strategy hold up in 2008 and 2009? JB: We certainly suffered much of the pain everyone did, but one advantage we have is that our average client has been with us for close to 20 years. They value and share our long-term perspective, and were willing to ride through that period with us. That gave us the luxury of not having to liquidate holdings at exactly the wrong time, which positioned the portfolio well to come back as quickly as it did.
Most of the trends youve discussed are positive ones. What worries you the most on the downside? JB: My biggest concern is that the U.S. doesn't get its fiscal, monetary, and regulatory-policy house in order to support economic growth. The federal budget deficit and national debt are trending to levels that will have dire, long-term economic and social consequences if not reversed. We need a policy regime that not only reduces the burden of government spending, but also increases the incentives for work, risk-taking and capital formation. I'm optimistic, but there is a risk we don't learn from Europe and Japan, whose policies on a variety of fronts have produced economic lethargy. If that happens and we keep trying to muddle along as we currently are at the policy level, our portfolios will have to have a dramatically different complexion than they do today. VII
February 29, 2012
A F R E S H L O O K : WellPoint
Addition by Subtraction
Investors always have to assess whether news about a company is noise to ignore, or something important on which to act. For Soapstone Capitals Jed Nussdorf, it's been more the latter for WellPoint than the former.
With details about healthcare reform more solidly on the table, Jed Nussdorf of Soapstone Capital a year ago saw good news on the horizon for managed-care giant WellPoint [VII, February 28, 2011]. In particular, he expected the reform act's inclusion of Medical Loss Ratio [MLR] minimums to create an incentive for providers to push plan pricing higher, resulting in a hard market that could last at least through 2013. The result would be better-than-expected earnings for WellPoint and significant upside in the share price, then at $66.50. All proceeded well, as relatively strong insurance prices and a benign medicalcost environment bolstered the results of WellPoint and competitors such as UnitedHealth and Aetna. Through June, WellPoint's stock traded above $80. At that point, however, Nussdorf started hearing of pushback on pricing from brokers and clients who were loathe to accept big increases when medical costs were running lower than usual. While he didn't expect pricing to turn soft, the change in sentiment after a strong run in the stock prompted him to sell roughly one-third of his WellPoint position. The more concerning news hit with the Q2 2011 earnings report, which indicated that problems in areas such as the company's Medicare preferred provider organization business and in its California commercial lines would keep it from enjoying a banner year. The sun was shining, says Nussdorf, but WellPoint wasn't making hay. On that news, with the shares around $70, Nussdorf sold more of his stock taking his position to 20% of what it had been last February. As the performance gap between WellPoint and its top competitors has widened as measured by its Medical Loss Ratio Nussdorf has become more disillusioned. In September he wrote a letter to the company's board detailing why he believed current management should
February 29, 2012
be removed. In particular, he fears that when health-insurance exchanges upend the status quo for managed-care providers starting in 2014 shifting responsibility for buying insurance from employers more to individuals WellPoint will be as woefully out-executed as he believes it has already been in the comparable Medicare Advantage market. Why hold the stock, now around $65.50, at all? Despite its home-grown problems, he says the company remains the low-cost provider with the highest local market shares through its dominant Blue Cross/Blue Shield network. It also
INVESTMENT SNAPSHOT
has earnings leverage which could make today's share price look exceedingly cheap. If WellPoint's MLR got within 100 basis points of the level achieved prior to current management taking over, he says, the company would earn close to $12 per share this year. Were it to catch up and match the membership growth its peers realized over the past five years, earnings power would be as high as $15 per share. There's still an opening for the company to get back on track, he says. The upside if that happened is big enough that it's worth maintaining at least a small position for now. VII
WellPoint
(NYSE: WLP)
WLP PRICE HISTORY 100
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80
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60
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2012 VII, February 28, 2011
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Share Information (@2/28/12):
Valuation Metrics (@2/28/12):
Price
52-Week Range
$65.54
$56.61 $81.92 Trailing P/E Forward P/E Est.
WLP 9.0 8.5
S&P 500 15.8 13.1
ORIGINAL BOTTOM LINE FEBRUARY 28, 2011
The investment thesis for the company, says Jed Nussdorf, has shifted from a why it wont be so bad focus to a more offensive why it will be good one, based on increased pricing power. At 12x his estimate of what will then be the next twelve months earnings per share, the stock 18 months from now would trade around $100.
NEW BOTTOM LINE
Some pushback on plan pricing and poor company execution has led Jed Nussdorf to cut his share position by 80%. He maintains a stake because the upside is considerable probably under new management if the company were to get back on track.
S T R A T E G Y : Seth Klarman
Dangerous State of Affairs

Investing legend Seth Klarman in his latest Baupost Group annual letter makes it clear that there is much for investors to worry about today. But with the right mindset, he says, there are opportunities to be found as well.
Editors Note: We always invest fully prepared for adverse scenarios to unfold, writes Seth Klarman in his latest Baupost Group annual letter to investors. Careful followers of Klarman in the 30 years since he founded Baupost know that to be true, as his long-term, absolute return oriented, value investing approach spans a broad range of asset classes, hedges liberally, puts primary emphasis on margins of safety and typically holds a high cash balance in excess of 33% on average across his investment partnerships since 2001. All that while generating long-term net returns that are the envy of the industry. In these excerpts from his just-published letter, Klarman examines the precarious macroeconomic environment investors face today, key challenges facing the U.S. and how to overcome them, insights from behavioralfinance expert Daniel Kahnemans new book, and why he believes investors should not be single-mindedly focused on bad news. Today's dizzying and daunting market volatility is driven by astonishingly shortterm investor thinking. Over the course of 2011, the S&P 500 Index fluctuated 2% or more on 35 days (based on closing prices many more if you include intraday moves) only to end up almost exactly where it started. Some days, an economic green shoot emerges, and investors fantasize a bumper crop and buy. Other days, the news is disappointing, and investors sell. On really bad days, investors fear the world may be ending, that our problems of excessive leverage and undercapitalized banks will never be solved, and urgently unload. Then, one or more governments or agencies take action nearly always with freshly printed money or cost-free guarantees or hint that they are about to, and investors decide the world will survive one more day and jump back in. A crisis erupts, followed by
February 29, 2012
intervention that staves it off for the moment. Another crisis, another quick fix, or vague promises of one. We are truly in uncharted territory. Official government policy in the U.S. and Europe essentially consists of economic and monetary whack-a-mole, targeting immediate symptoms but never the root causes. Pretend and extend reigns, no problems are ever fully solved, and the future is endlessly mortgaged and re-mortgaged.
ON KEY RISKS: Stocks that have declined 10% or 20% may be cheap, but it is much harder to know if they are cheap enough.
While we insist on investing based on what we see, many seem determined to commit capital based on the muscle memory of what things used to be like or on the undying hope for a full-bore recovery that never seems to arrive. The knee-jerk response of many investors to each successive crisis has been to anticipate a quick fix and buy the stock market's dips. Stocks that have declined 10% or 20% may be cheap certainly they are cheaper than they were but it is much harder to know if they are cheap enough: cheap enough to withstand an economic double dip and the resultant poor earnings; cheap enough to hold their valuation should corporate profit margins revert to their historic mean, or worse; and cheap enough to still be glad you bought them after they trade a lot lower. The absence of yield in the developed world is unprecedented since the Great Depression, yet investors are becoming acclimated to, and probably dangerously complacent about, today's low interest rates, which can hardly be a permanent
condition. The 30-year Treasury returned a whopping 22.8% in 2011, as yields fell to 2.9% at year-end; 10-year U.S. Treasuries ended the year at a 1.9% yield. Such scant yields are certainly inadequate recompense for the long-term commitment of capital in the face of soaring U.S. government debt and printing presses that never stop cranking away. Many investors use the anchor of the risk-free interest rate to tether their valuation models. Even though riskless investments have never really existed (there is no such thing), the conventional wisdom has been to consider U.S. Treasury bills a proxy for a risk-free investment. All investors, to some extent, think about return relative to what they could earn while taking no risk. Today, with all sovereign debt under suspicion and for good reason even a traditionally slow-to-act rating agency has figured out that U.S. government securities are not without risk. While in our view the possibility of a default by the U.S. is remote because all of our debt is denominated in our own currency, and we would inevitably print money to meet all our obligations under any circumstance, the ensuing currency debasement would hardly be risk-free to holders of medium or long-term U.S. government debt. With no risk-free rate to guide them, and government interest rates across the yield curve being manipulated by quantitative easing, investors are no doubt finding it harder than usual to get their bearings. We are living through an epic and highly dangerous state of affairs. Will the deflationary pressures of the ongoing debt implosion swamp rescue attempts by governments to prop up the institutions and entities that comprise the system? Or will governments have sufficient ammunition the debt capacity, the easy money policies, continued support of the voters, unwavering investor confidence to stem
the collapse? And, if so, at what cost? Will the price be paid in future runaway inflation? Will we reach a tipping point where confidence in the system is lost? Have we reached it already? At a minimum, we are expecting ongoing volatility, with episodic crises and intermittent rallies. At worst, investors will continue to experience things that have never before occurred, blowing historic relationships to smithereens, providing a costly education to the incurious and complacent, and severely damaging the purchasing power of paper money. America's Challenges We must strive to learn the lessons that led to unprecedented American prosperity for the great majority of our 235 years. Certainly, investment in education, technology, infrastructure, and scientific advancement should be at the top of the to-do list. Higher energy taxes, which would wean us off fossil fuels while encouraging the development of alternatives, are a no-brainer, especially when the externalities of carbon emissions and national security are factored in. Ensuring that every American has the opportunity to succeed is crucial. Our politicians need to soberly assess the country's precarious situation, deliver some tough messages that politicians hate to deliver and voters don't like to hear, and call on all of us and we, collectively, need to meet the call for hard work, community service, shared sacrifice, and a commitment to pull together to restore national greatness. You will find the same underlying cause at the root of the budget stalemate in Washington and in the government policies that contributed to the ongoing financial crisis: a dangerously and foolishly short-term orientation focused primarily on winning re-election. As we have noted over the years, most in the investment business cannot take the necessary long-term view, propelled as they are by swings in emotion that match financial market gyrations; they focus instead on the month or quarter ahead, fearing that the long-term doesn't matter if you are
February 29, 2012
fired in the short-term. No one can reliably perform under such pressure, whether real or imagined. In Washington, similarly, we desperately need leaders who will stop telling us what we want to hear, who will start asking us to do something for the country instead of asking what the country can do for us, and who will do the right thing in addressing both our immediate problems and intractable longer-term ones even if it means risking being voted out of office. While no one can question the need for a government to pave roads, enforce laws, and provide for national defense, the bloated bureaucra-
ON FLAWED POLICY: People got the foolish impression that downward cycles could be repealed through government interventions.
cy, heated rhetoric, endless stalemate, unaffordable promises, poorly designed programs that never die off, and inability to tackle our nation's problems have caused many to ask whether our government has become a net negative. You would not jump to invest in the stock of a company whose CEO was obsessively fixated on the company's daily share price fluctuations, because you would greatly prefer his or her attention be completely focused on what was required for the long-term success of their business. What, then, are we to make of the nation's Central Banker, who stares at the national Bloomberg screen and marvels about the impact of his policies on stock prices which have no appreciable impact on the unemployment rate or on economic growth? Or the feckless politicians who calibrate their actions by watching the latest polls? Corporate executives who behaved this way would be fired by a competent board. For decades, politicians have promised us more than can be affordably delivered, resulting in a diminished sense of selfreliance among the populace. There have
always been episodic tough times. We get through them, and move on to something better. However, a few decades ago, without even realizing it, our government (and its overconfident economic advisors) decided that, through clever fiscal and monetary policies, we could do away with down cycles. Monetary maneuverings and relentless deficit spending would tip the scales so declines wouldn't be as sharp or protracted; in theory, we would also use the up cycles to balance our books, pay down our debts, and even replenish the coffers though this part rarely happened. When times were good, people wanted them to be even better. People got the foolish impression that the downward part of cycles could be repealed through government interventions; serving up this free lunch, that economists say can't exist, somehow became national policy. Elie Wiesel once said, God gave Adam a secret and that secret was not how to begin, but how to begin again. America in 2012 needs to begin again. Our nation's greatness has always derived from the core principles upon which it was founded justice, personal freedoms, rule of law, social and economic mobility, opportunity for all. It comes from the people courageous, sturdy, self-reliant, fair-minded, charitable, entrepreneurial, and hard working. With a re-emphasis on these roots, we can, like Adam, begin again. With the intellectual honesty to accurately assess our problems and identify the shortcomings of our current system, it is not too late to turn this situation around. Time is running out, but with strong leadership, a determined effort, and selfless attitude, we can get through our troubles, restore our economy and our lost confidence, and regain our national greatness and leadership position in the world. Behavioral Insight Despite the number of actual rocket scientists who have flocked to the investment business, securities prices aren't subject to Newtonian principles, only behavioral ones. Most of us like a stock
more when it has risen in price and less when it has fallen, even though this is antithetical to its investment merits, which can only be determined by comparing price to underlying value. Investors emotionally pile in on good news, and rush for the exits on bad, frequently causing prices to overshoot. Value investors know although efficient market believers fail to comprehend that the underlying value of a security is distinguishable from its daily market price, which is set by the whim of buyers and sellers, as are the prices of rare art and other collectibles. Investors must remember although at the peak of emotion they sometimes forget that securities are fractional interests in, or claims on, businesses that have their own assets and cash flows. They have (usually) ongoing business value and (at least hypothetically) a liquidation value. The herd can irrationally lose sight of the underlying assets or long-term prospects of a business when it focuses on price movements triggered by disappointing quarterly results or the latest overheated social networking IPO. Often, a company's share price fluctuates significantly even in the absence of fundamental developments, such as when a sizeable seller needs cash quickly. Daniel Kahneman, a psychologist who won the Nobel Prize in Economic Sciences for his work that challenged a rational model of judgment and decisionmaking, recently published a remarkable account of his intellectual journey: Thinking, Fast and Slow.1 The implications for those who believe that we are always rational actors are quite disheartening. Kahneman does not, by the way, brand people as irrational; he simply believes that the idea that we are always rational actors does not hold water. Kahneman thinks of the human brain as operating on two systems simultaneously. System One, the fast brain, is mostly on autopilot responding to millions of inputs on a daily basis, forming quick and mostly reliable impressions. System One helps us discern friend from foe, or edible from poisonous. It controls our driving on a familiar highway, so that when we arrive at our destination,
February 29, 2012
we hardly remember how we got there. We need System One to navigate the world. System Two is slow. System One knows that two plus two is four without doing the math. System Two is needed to know that 17 times 24 equals 408. We have to slow down and think. System One is prone to leaping to conclusions. It sometimes substitutes the question you are responding to with a similar one to which it has a ready answer. Mostly, these intuitive judgments are accurate and helpful, but sometimes our first response is not the one we would give if we took more time and thought harder about the problem.
ON INVESTOR BIASES: It is at times easier to predict how investors will behave in certain situations than to predict a companys bottom line.
System One needs System Two to slow it down, but there are times (exhaustion, alcohol consumption, heat of the moment) when System Two loses out to System One. Even if you've never considered it before, the idea of these two systems simultaneously operating in our brains will ring true. One of the places that Kahneman arguably falls short is in his discussion of investment management. He regards the investment industry as having been built on an illusion of apparent skill because the number of investors who reliably outperform the market is a small one.2 Ironically, Kahneman fails to recognize that it is precisely because of the biases in our thinking and the constraints and pressures placed on people in the industry that recurrent mispricings and inefficiencies exist for those who are able to resist the pressures of conformity and shortterm performance measurement, and who know where to look for mispricings. Understanding how our brains work our limitations, endless mental shortcuts,
and deeply ingrained biases is one of the keys to successful investing. At Baupost, we believe that it is sometimes easier to predict how investors will behave in certain situations than it is to predict a company's bottom line. At times of market extremes, by avoiding emotional overreaction and remaining aware of our biases, it may be possible to know market participants better than they can know themselves. How can we improve our thinking? Kahneman, notes that the voice of reason (System Two) may be much fainter than the loud and clear voice of an erroneous intuition (System One). Questioning your assumptions is unpleasant when you face the stress of a big decision; more doubt is the last thing you want when you are in trouble. We would all like to have a warning bell that rings when we are about to make a serious error, but no such bell is available. It turns out that it is much easier to identify a minefield when you observe others wandering into it than when you are about to do so yourself. Observers are less cognitively busy and more open to information than actors.3 Interestingly, organizations can fare better than individuals when it comes to avoiding errors, because they think more slowly and have the power to impose orderly procedures (such as Atul Gawande's compelling research on the benefit of checklists for hospital surgeries) and sound processes (such as within an investment firm). Organizations can also encourage a culture in which people watch out for one another as they approach minefields. As Kahneman notes, Whatever else it produces, an organization is a factory that manufactures judgments and decisions. An organization that seeks to improve its decision product should routinely look for efficiency improvements ... in the initial design, in fabrication, and in final inspections.4 Investing lies at the intersection of economics and psychology, the place where net present value meets greed and fear. It is important to know the numbers but that is not sufficient. And it is important
to know how people think but that, too, is not enough. Both matter; it is, of course, good to buy investment bargains, but it is far better if you know why they are bargain-priced. Kahneman helps us understand some of the reasons why markets can be inefficient and thus why bargains exist. Beyond human emotion and biases, market inefficiencies and imperfections are also caused by institutional constraints: man-made rules imposed by clients, regulators, or ourselves. These are generally straightforward, such as the desire to impose prudent behavior on investment managers by requiring them to invest only in bonds that are investment grade or in stocks that are currently paying a dividend. This means that suddenly downgraded or defaulted bonds or dividend-omitting equities could immediately come under intense selling pressure falling to undervalued levels. These constraints make intuitive sense when first imposed, yet they handcuff investors, forcing them to buy or sell based on criteria unrelated to, or even in contradiction of, underlying fundamental value. Failures in rationality driven by biases can combine with market failures caused by man-made constraints, leading to opportunity for those not so biased or
Value Investor Insight is published monthly at www.valueinvestorinsight.com (the Site), by Value Investor Media, Inc. Chairman and Co-Editor-in-Chief, Whitney Tilson; President and Co-Editor-in-Chief, John Heins. Annual subscription price: $349. by Value Investor Media, Inc. All rights reserved. All Site content is protected by U.S. and international copyright laws and is the property of VIM and any third-party providers of such content. The U.S. Copyright Act imposes liability of up to $150,000 for each act of willful infringement of a copyright. Subscribers may download Site content to their computer and store and print Site materials for their individual use only. Any other reproduction, transmission, display or editing of the Content by any means, mechanical or electronic, without the prior written permission of VIM is strictly prohibited. Terms of Use: Use of this newsletter and its content is governed by the Site Terms of Use described in detail at www.valueinvestorinsight.com. See a summary of key terms on the following page of this newsletter. Contact Information: For all customer service, subscription or other inquiries, please visit www.valueinvestorinsight.com, or contact us at Value Investor Insight, 2071 Chain Bridge Road, Suite 400, Vienna, VA 22182; telephone: 703-288-9060
February 29, 2012
2012
constrained. Since all of us have predispositions toward certain biases, no one should be confident that they are immune from irrational behavior from time to time. Our hope is that by being aware of this possibility, by working as a team with a robust investment process, and by avoiding self-imposed constraints and
THE OPPORTUNITY SET: Long-term investors should not become single-mindedly focused on bad news . . . when we find bargains, we buy them.
bureaucracy, we will be able to take advantage of opportunities dished up by others, while minimizing the possibility that our own behavior leads to costly mistakes or foregone opportunity. Finding Bargains While the range of conceivable economic and market scenarios remains extremely wide, it is important that longterm investors not become single-mindedly focused on bad news. Although the
U.S. equity market gained modestly during 2011, global stock markets lost over $6 trillion of value, a decline of about 12%. Even after 2011's small gain, the S&P 500 delivered a total return (with dividends reinvested) of only 6.8% over the past twelve years. Even more strikingly, the 30-year total return (for the period ended December 31) on long-dated U.S. Treasuries actually eclipsed the total return on the S&P 500 over the same three decades. Lengthy periods of belowaverage stock market performance are often followed by times of above-normal returns. At lower market levels, significant risk is often priced in. Meanwhile, cash yields zero, while the investments we are making offer projected annual returns in the mid- teens or higher, with limited downside risk under what we believe are conservative assumptions. In short, while our macro view remains one of serious concern, we are determined to stay focused on the identification of bottomup, low-risk opportunity, and to invest solely on that basis. When we find great bargains, we buy them. VII
Footnotes: 1Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2011); 2Kahneman, 212-217; 3Kahneman, 417; 4Kahneman, 418.
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Value Investor Insight and SuperInvestor Insight are published at www.valueinvestorinsight.com (the Site) by Value Investor Media, Inc. Use of this newsletter and its content is governed by the Site Terms of Use described in detail at www.valueinvestorinsight.com/misc/termsofuse. For your convenience, a summary of certain key policies, disclosures and disclaimers is reproduced below. This summary is meant in no way to limit or otherwise circumscribe the full scope and effect of the complete Terms of Use. No Investment Advice This newsletter is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. This newsletter is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a general or personal recommendation or take into account the particular investment objectives, financ ial situations, or needs of individual investors. The price and value of securities referred to in this newsletter will fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of all of the original capital invested in a security discussed in this newsletter may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors. Disclaimers There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth in this newsletter. Value Investor Media will not be liable to you or anyone else for any loss or injury resulting directly or indirectly from the use of the information contained in this newsletter, caused in whole or in part by its negligence in compiling, interpreting, reporting or delivering the content in this newsletter. Related Persons Value Investor Medias officers, directors, employees and/or principals (collectively Related Persons) may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated in this newsletter. Whitney Tilson, Chairman of Value Investor Media, is also a principal of T2 Partners Management, LP, a registered investment adviser. T2Partners Management, LP may purchase or sell securities and financial instruments discussed in this newsletter on behalf of certain accounts it manages. It is the policy of T2 Partners Management, LP and all Related Persons to allow a full trading day to elapse after the publication of this newsletter before purchases or sales are made of any securities or financial instruments discussed herein as Investment Snapshots. Compensation Value Investor Media, Inc. receives compensation in connection with the publication of this newsletter only in the form of subscription fees charged to subscribers and reproduction or re-dissemination fees charged to subscribers or others interested in the newsletter content.
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ValueInvestor

February 29, 2012

The Leading Authority on Value Investing

Art and Science

Inside this Issue

Seeing the Forest

Other companies in this issue:

Investor Insight: Sarah Ketterer

Not Far From the Tree

Trailing P/E Forward P/E Est.

S&P 500 15.8 13.1

Largest Institutional Owners

% Owned 10.9% 6.2% 4.1% 3.7% 2.7% 2.4%

Revenue Operating Profit Margin Net Profit Margin

10 2010 2011 2012

THE BOTTOM LINE

February 29, 2012

Revenue Operating Margin Net Profit Margin

60.93 billion 6.3% 4.4%

3.18 3.11 4.23 5.1% 25.49 billion

S&P 500 15.8

4.50 4.00 3.50 3.00 2.50

THE BOTTOM LINE

February 29, 2012

Revenue EBIT Margin Net Profit Margin

2.66 billion 5.8% 5.0%

30.58 21.50 43.74 4.4% 1.69 billion

Russell 2000 41.3

THE BOTTOM LINE

Babcock & Wilcox

Trailing P/E Forward P/E Est.

BWC 19.5 15.1

S&P 500 15.8 13.1

Largest Institutional Owners

% Owned 17.7% 12.0% 8.0% 5.3% 3.9% 0.7%

Revenue Operating Profit Margin Net Profit Margin

THE BOTTOM LINE

February 29, 2012

Investor Insight: Jay Bowen

Canadian Pacific Railway

Trailing P/E Forward P/E Est.

S&P 500 15.8 13.1

Largest Institutional Owners

% Owned 14.2% 5.1% 4.4% 3.9% 3.0% n/a

Revenue Operating Profit Margin Net Profit Margin

THE BOTTOM LINE

February 29, 2012

Trailing P/E Forward P/E Est.

TCK 9.1 10.2

S&P 500 15.8 13.1

Largest Institutional Owners

% Owned 17.5% 8.9% 3.7% 2.2% 2.2% n/a

Revenue Operating Profit Margin Net Profit Margin

THE BOTTOM LINE

February 29, 2012

Trailing P/E Forward P/E Est.

XYL 15.3 12.7

S&P 500 15.8 13.1

Largest Institutional Owners

% Owned 7.0% 5.2% 3.6% 3.0% 2.3% 2.7%

Revenue Operating Profit Margin Net Profit Margin

20 2010 2011 2012

THE BOTTOM LINE