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From tractor makers to reinsurers to hospital companies, the stocks John Schneider picks seem to have one thing in common: value. That has put the PIMCO portfolio manager right in the market's sweet spot this year, as investors flee go-go momentum plays in favor of certifiably cheap stocks of improving companies.
Schneider is responsible for some $800 million, including every penny in PIMCO's Renaissance (PDLAX
) funds, which are up 24% and 21%, respectively, through Nov. 28. When I reached him by phone this week, he filled me in on the reasons why the new millennium has treated him well, plus what he's counting on to power the funds in 2001. Edited excerpts of our discussion follow:
Q: What's clicking for you this year?
A: Obviously, technology has pulled back, and value stocks have come back. Also, we've had some pretty good stock selection.
Q: Insurance stocks among them, correct?
A: Absolutely -- property and casualty insurance stocks. Ace Ltd. [XL
], Everest Re Group [LTR
], which is a conglomerate but it owns CNA [CNA
].
Q: I see. Do you still own those and expect gains ahead, or are you collecting profits?
A: I still own them all. I think they've got quite a bit in front of them, but I've peeled back a little.
Q: You also have health-care stocks. Which ones do you like?
A: I like the hospitals and the HMOs. In the hospitals, I own Tenet [HRC
]. And in the HMOs, I own Aetna [HNT
].
Q: What is it you like about Aetna?
A: Aetna has been the laggard of the group. They're now...trying to raise prices and cut costs.
Q: Aetna also has a new CEO, Dr. John Rowe, formerly of Mt. Sinai NYU in New York City, waiting to take over, right?
A: He's making quite a change, from a nonprofit hospital chain to a for-profit HMO.... He shows a lot of enthusiasm. I think he's going at the right issues.... It's not going to be a quick turnaround for the HMO, but their margins are so depressed relative to their peers' that I think there is opportunity. [I see] $4 in cash earnings next year, and that's a value [next to the stock's price], but if this new guy does anything right, $4 is going to look like a low number.
Q: How about Health Net, which everyone used to know as Foundation Health Systems?
A: They're actually doing things much better. They have a very strong franchise in California and here in the tri-state [New York-New Jersey-Connecticut] area. They're raising prices to reflect their higher medical costs. As a result, their margins are getting better. They've been growing earnings by 20%-plus [annually], and they're getting out of territories where they're a weaker player, like in Florida and Nevada. There's still more earnings improvement [to come] as they get out of businesses where they're losing money, such as Medicare.
Q: So they're getting out of Medicare?
A: They're cutting it substantially.
Q: Aetna is, too. Why?
A: Basically, you've had medical inflation in the high single digits, call it 7%, 8%, 9%. Government for the past couple of years has only been raising the [reimbursement] they give HMOs for the Medicare business 2% or 3%. So the vise has just been getting tighter and tighter. HMOs have been able to offset that to some degree by reducing benefits, but basically...[President] Clinton...hasn't wanted HMOs to pick up this Medicare business, so he has made it not advantageous.... [As a result,] everybody has been losing money and pulling back.
Q: How about on the hospital side of the health-care industry?
A: I like Tenet. It's an acute-care hospital chain, the second-largest in the country. They're getting price increases.
Q: HealthSouth, too?
A: It's a little different. They're the largest inpatient and outpatient rehabilitation hospital in the country, with something like 30% market share. What's going on there is the government has been paying them for inpatient rehab services at cost. For HealthSouth, this is a pretty significant part of their business, and they've been receiving no profit on it. Now, the government has just enacted a system where they pay a set-dollar amount. HealthSouth is a quality provider, but a low-cost provider because of its scale, so they're going to be able to make a significant profit on this.
Q: Go on.
A: When fully enacted, this will add something like 20 cents [per share] to earnings, which isn't in Wall Street's earnings estimates yet.
Q: That will show up in 2001?
A: Yes, it will start in the latter part of 2001.
Q: What other parts of the market do you like?
A: One area that I'm warming to is this whole ag area. I own food processors like Archer-Daniels-Midland [CPO
] and tractor makers Deere [CNH
].
Q: What do you see happening on the farm?
A: The farmer, after a number of years of being on his back, is now doing reasonably well. In the face of the economy weakening, [agriculture] is an area where it's on its own cycle, and I think things are improving. The [number of] tractors that are being sold are dramatically below the replacement number over the long haul, and I think that as tractors age, there's going to be a replacement cycle. [Tractor makers] have reduced their break-even points. CNH especially has very, very large cost savings.
Q: What else do you own?
A: Suiza Foods [SZA
], which is the largest milk producer in the country. I think the whole [farming] sector has been overlooked.
Q: Finally, what kind of investor should avoid your fund?
A: The guy who's going to day-trade. I don't want him in my fund. I'm looking out 12 to 18 months, and some of these stocks take a little while. So on a given week or a given month, there might be a bit of bumpiness. But in the long run, we've done pretty well, and I think that should continue.
Barker covers personal finance in his Barker Portfolio column for Business Week. His barker.online column appears every Friday, only on BW Online.
Questions? Comments? Let us know at our barker.online interactive forum Edited by Patricia O'Connell
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