Seth Klarman’s Q1 Top Stock Picks

BAUPOST GROUPLast year was not a good year for hedge funds. The entire hedge fund industry struggled during the past year, but there were some exceptions. Take Seth Klarman’s Baupost Group for example. It ended 2011 on a gain. Klarman believes that the company’s “focus on risk-aversion and the pursuit of excellent long-term results” instead of focusing on “quick gains, short-term trades and market momentum” is the main reason for its success. Since its inception in 1982, Baupost Group has returned an average of about 20% annually. It is currently the 11th largest hedge fund in the world with approximately $24 billion AUM.

Recently, Klarman released its holdings at the end of the first quarter in a 13F filing. In this article, we are going to take a closer look at the largest positions in Klarman’s 13F portfolio.

News Corp (NWSA): News Corp was the largest position in Klarman’s portfolio at the end of the most recent quarter. It was also the largest position in the fund at the end of the previous quarter. As of March 31, 2012, Baupost Group had $500+ million invested in News Corp. The stock is very popular among the hedge funds tracked by us. There were 62 hedge funds with News Corp in their portfolios at the end of 2011. Besides Klarman, Eric Mindich and Boykin Curry are also bullish about News Corp. Both of their funds had more than $400 million invested in the company at the end of last year (check out Eric Mindich’s top stock picks).

News Corp’s share price has gone up 16.61% over the past 52 weeks, heavily beating the 2.50% for the S&P 500 index over the same period. Despite that, News Corp is still trading at reasonable valuation levels. Its EPS is estimated to be $1.38 this year and $1.70 next year. Trading at around $20 per share, News Corp had a forward P/E ratio of 14.5 and a P/E ratio for 2013 of 11.8. Gannett Inc (GCI), one of News Corp’s main competitors, seems to have lower multiples – Gannett’s 2013 P/E ratio is just 6.2 – but Gannett’s earnings are expected to grow at only 9% per year, versus 20% for News Corp. Another competitor Time Warner Inc (TWX) also has a lower 2013 P/E ratio of 9.83, but its expected earnings growth rate is 11%, also lower than that of News Corp. Moreover, Time Warner’s revenues are expected to decline at 13.67% annually (check out our previous article about News Corp and its peers).

BP Plc (BP): Another large-cap stock Klarman made a large bet on was BP. It was the third-largest position in Klarman’s latest 13F portfolio. Klarman reported owning $419 million worth of BP shares at the end of March. BP is the most popular energy stock amongst the hedge funds we track. As of December 31, 2011, fifty-seven hedge funds had BP in their 13F portfolios, including fund manager Eric Mindich. His Eton Park Capital had $215 million invested in BP at the end of last year. Billionaire Jim Simons’ Renaissance Technologies also invested about $100 million in BP (check out Jim Simons’ top stock picks).

BP is expected to earn $6.46 per share in 2012, rising to $6.76 per share in 2013. Its earnings are expected to grow at an average of 4% over the next few years. The stock is currently trading at slightly below $40, or 6X its 2012 earnings, while the industry average forward P/E ratio is about 12. We think the market is over concerned about the negatives surrounding the company.

Though the Gulf of Mexico oil spill accident in 2010 has largely hurt BP’s public image and raised many uncertainties, the company is recovering from the incident. The company has also been actively restructuring its operations. It plans to sell approximately $45 billion of its downstream assets. By the end of 2012, the company expects to sell its refineries in Texas, Carson, and California. It is also modernizing its Whiting refinery to handle heavy crude.

The funds generated from the sale of its non-core assets have been used to cover the claims related to the oil spill, make acquisitions and investments, as well as pay out dividends. BP is a good dividend play. Its current dividend yield is 4.84%, versus 2% for the 10-year Treasury bond. Though the company cut its dividend payments by half after the oil spill incident, it raised it dividends by 14.3% this year. BP also has a low payout ratio of only 23%, indicating its great potential of increasing dividends in the future.

Other Companies: Klarman also invested a large amount of capital in ViaSat Inc (VSAT), Hewlett Packard Co (HPQ), and Theravance Inc (THRX). Klarman did not increase or decrease his stakes in ViaSat over the first quarter. He slightly increased his position in Theravance by 2%, but we think the stock is a bit risky. Theravance is still in the development stage. It invests heavily in research and development, and has high costs. Its per-share losses are expected to be $0.37 in 2012 and $1.77 in 2013. We think Theravance is a bit risky to invest in, instead preferring companies in a more mature stage, such as Gilead Sciences (GILD). We like Hewlett Packard though. The stock is trading at only 5.8X its 2012 earnings and its earnings are expected to grow at 7% per year. Forty-four hedge fund managers also see great potential in the company, including Wallace Weitz and Ray Dalio (see Ray Dalio’s top stock picks).

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