TheChek News Flow

VIENNA—The morning after OPEC officials deadlocked about how to implement oil-production cuts, the cartel’s leader warned of dire consequences for the oil industry if the group doesn’t move forward with a plan to reduce output.

In a speech here Saturday morning, Mohammad Barkindo, secretary-general of the Organization of the Petroleum Exporting Countries, said “the recovery process [in rebalancing oil markets] has taken far too long and we cannot risk delaying the adjustment any further.”

OPEC nation representatives are meeting at the group’s headquarters here with producers outside the cartel to discuss a tentative deal to reduce a global oil oversupply. The glut, caused by a flood of production from both OPEC and the U.S., has depressed crude prices for over two years, hurting petroleum-dependent economies from Venezuela to Saudi Arabia.

OPEC agreed last month in Algiers to reduce its production by between 200,000 and 700,000 barrels a day—about 1% to 2%—to reduce high oil inventories. But OPEC officials on Friday couldn’t agree on a framework for implementing the cuts, with members Iran and Iraq refusing to agree to cut or even hold steady their burgeoning output.

“Anything short of implementation of this accord could lead to the elongation of the rebalancing process,” Mr. Barkindo warned Saturday.

The discussions this weekend are supposed to pave the way for a detailed proposal submitted to oil ministers from OPEC’s 14 nations on Nov. 30. Instead, Iraq and Iran’s insistence on exemptions have emerged as a big sticking point Friday, threatening the agreement’s viability.

Iran wants to keep pumping until it reaches 4.2 million barrels a day, an increase of 400,000 barrels a day from current levels, according to an Iranian oil official. Iraq says it needs to keep pumping to generate revenue for an intensifying war against Islamic State. Iraqi officials didn’t respond to requests for comment Saturday.

But Saudi Arabia—the group’s kingpin and regional rival to Iran—insists Tehran should shoulder at least part of OPEC’s efforts in rebalancing markets, according to oil officials in the group. Exempting Iraq and Iran would put pressure on Saudi Arabia, OPEC’s largest producer, to cut more output than the kingdom wants to.

A lack of action so far to revive flagging oil prices is leading officials such as Saudi oil minister Saudi oil minister Khalid al-Falih to warn that oil-industry spending cuts caused by low prices will lead to supply shortfalls soon. According to energy consultancy Wood Mackenzie, over $1 trillion in oil-industry capital spending has been slashed since oil prices began falling in 2014.

Mr. Barkindo echoed that view Saturday. Failure to implement the Algiers deal will lead to “further deterioration of financial conditions and setbacks in investments extending into a third year, which would be unprecedented,” he said.

The Algiers agreement was also dependent on producers outside the group joining to the curbs. Russia, which doesn’t belong to OPEC but produces more crude than any other country, has tentatively agreed to cooperate but without specifics.

But as they arrived at the cartel’s Vienna headquarters Saturday morning, non-OPEC producers refused to provide detailed commitments to turn off the spigots.

Senior Brazilian oil official Marcio Felix told reporters he was there to “listen” and his country intended to boost production next year. A Kazakh official said the only outcome he expected was to push oil prices higher.

Azerbaijan Energy Minister Natig Aliyev said his country hopes “some measures will be taken to stabilize the oil market” but declined to say how much his country could afford.

“Everything will depend on the position of countries, primarily OPEC members such as Iraq and Iran,” Mr. Aliyev said.

Oman, another non-OPEC producer attending the meeting Saturday, is taking a similar stance. The Persian Gulf producer is willing to reduce production as part of a broader deal with OPEC and producers from outside the group, but won’t commit to a specific size of cut until the cartel reaches a solid agreement, a senior Omani official said.

Hotel investors are sleeping fitfully after weak earnings results sank lodging stocks last week and raised fears that the industry’s lengthy growth cycle is ending.

In the case of Hilton Worldwide Holdings (ticker: HLT), however, a cheap stock looks like an opportunity. McLean, Va.–based Hilton is opening hotels in profitable markets overseas, and planning to split into three companies whose earnings and cash flow should grow, even if the hotel industry stagnates in the U.S. Hilton’s shares recently fetched $22.25. The company could be worth at least 25% more in the next year.

Hilton offers “an attractive combination of reasonable growth, plus value, plus a clear catalyst,” says Jeff Kolitch, manager of the Baron Real Estate fund.

The catalyst is a plan to split before year end into one company that will hold the hotels that Hilton franchises and manages; a second that will hold its time-share properties; and a third to be spun off as a real estate investment trust that includes its owned hotels. Each company will have its own capital structure and growth plan.

In a vote of confidence, Chinese conglomerate HNA Group agreed on Monday to buy 25% of Hilton for $6.5 billion, or $26.25 a share, from Blackstone Group (BX), paying a 15% premium to the prior trading day’s closing price. Blackstone, which bought Hilton in 2007 and took it public again in 2013, will continue to own 21%.

HNA agreed to hold the shares for at least two years. The deal will unwind Blackstone’s stake with minimal market disruption, and give Hilton an intriguing new partner in a country that accounts for 20% of its new-hotel pipeline. HNA owns an airline and China’s second-largest online travel agency.

“There’s hardly a meeting I’ve had in the past two years where people didn’t talk about the overhang of Blackstone’s ownership,” said Hilton CEO Christopher Nassetta in an interview. “The deal we announced on Monday does a very elegant job of dealing with the bulk of the overhang and gives us an important strategic partner.”

Conrad Hilton bought his first hotel in 1919. But most of Hilton’s 4,800 properties are now owned by franchisees, or other parties who pay the company a fee, based largely on revenue. The U.S. accounts for 80% of adjusted earnings, but half of new rooms are being built overseas.

Last year, Barron’s praised the company (“Hilton: Check In for a 25% Gain,” May 23, 2015), but it has skidded 24% since then. Last week, Hilton lowered its full-year earnings guidance and gave a tepid 2017 forecast for revenue per available room, or RevPAR, a key gauge of pricing power, citing weak business travel.

Hotel occupancy and prices surged after the 2008-09 recession, but U.S. demand is slackening; it has trailed supply growth in two of the past three months, according to data firm STR. Hilton offers organic growth that could push revenue higher, regardless of industry trends. It controls less than 5% of the world’s hotel rooms but is growing its base by 6% to 7% a year, and has more than 20% of the global pipeline of new rooms. “We’re an unbelievably resilient model,” Nassetta says. “I don’t think the world is going backward, but if it did, we’re still growing.”

HILTON IS EXPECTED to earn $969 million, or 88 cents a share, this year, on $11.7 billion in revenue, up from 81 cents on $11.3 billion last year. The stock trades for 22 times 2017 earnings estimates, and 10 times enterprise value to next year’s estimated earnings before interest, taxes, depreciation, and amortization—a metric that analysts prefer because lodging companies differ broadly in capital structure. Some own hotels and take large depreciation charges, while others manage properties for a fee.

Hilton’s EV/Ebitda ratio has averaged 16.2 since the stock’s 2013 public offering. There is reason to believe that the shares have bottomed. “Lodging stocks have never traded below 10 times for an extended period, except during recession years,” says Morgan Stanley analyst Thomas Allen.

With the spinoff pending, Wall Street is valuing Hilton on a sum-of-the-parts basis. In a report last month, JPMorgan analyst Joseph Greff estimated the potential value of each new company based on his 2018 Ebitda estimates and enterprise-value-to-Ebitda multiples in line with peers. He figures that the segment holding the franchised and managed hotels, which generate substantial free cash flow from fee income, could trade for 11.5 times enterprise value to 2018 estimated Ebitda. The REIT, which will control 69 owned hotels with nearly 36,000 rooms, could fetch 9.5 times EV/Ebitda, and the time-share company, which runs 46 resorts, could sell for 7.5 times.

The REIT could offer even more upside in the form of a large dividend. Rival Host Hotels & Resorts (HST) yields 5.4%, and Nassetta expects Hilton’s dividend to be at least as robust.

Think of it as an extra pillow for your investment.

Martin Hughes had already established himself as a top-ranked bank analyst and was working at Credit Lyonnais Laing in London when he caught the attention of American hedge-fund legend Julian Robertson in 1997. Hughes was soon investing in global financial stocks for Robertson’s Tiger Management. It didn’t last long. Amid the dot-com crash in 2000, Robertson closed his hedge funds, but that was hardly the end of Hughes. He launched Toscafund Asset Management, named for the small Italian town where his wife’s family owns a home. Today, Hughes runs $3 billion from bright, open office space in London’s historic Covent Garden, where he’s built an excellent 16-year performance record.

A University of Birmingham graduate whose father was the proprietor of a kitchen-appliance shop in East London, Hughes is bullish on Britain’s prospects. He believes Brexit will “unwind the years of hindrance, regulation, and controls” and will “unleash the best in the British people.”

Hughes dismisses the recent weakness of the British pound as a “red herring” because it won’t rattle U.K. investors who’ve had to deal with its long rise and subsequent fall. Foreigners, he advises, should simply protect themselves from volatility by hedging.

Hughes, 55, has spent a large part of his career focused on the U.K., where he invests mostly in small private and public companies, trying to get in before they become too well- known to European investors and analysts at big brokerage firms. The biggest chunk of the firm’s assets, $900 million in all, is invested in Tosca Opportunity ($586 million) and a related fund that uses the same strategy. They target companies with market values of 50 million to one billion British pounds ($61 million to $1.22 billion).

One of the fund’s early British backers, Michael Kerr Dineen, compares Hughes to a talented broker or banker at a regional U.S. firm in a state like Kentucky, one who can spot emerging local businesses long before big Wall Street firms take notice.

TOSCA OPPORTUNITY IGNORES what Hughes deems “poor” brokerage research on small British companies. Instead, he relies on a team of 19 investment professionals–and his own intuition—to identify value plays. He rarely strays outside the U.K. All of his public holdings, regardless of domicile, are listed on the London Stock Exchange, where he feels comfortable with the regulatory standards. Hughes avoids companies that are difficult to understand or saddled with debt, preferring those with strong cash flow. The fund can short stocks, but Hughes has decided to keep the portfolio long-only for now.

“What we do is work out what someone will pay for this in the future,” Hughes toldBarron’s in a rare interview (rare, in part, because he dislikes the “Tiger cub” characterization journalists apply to every former Robertson employee). “If we can get a return of over 20% per annum, and be helpful to the company, we will consider buying,” he says.

With stakes in 17 private and public companies, Tosca Opportunity (one of the firm’s nine funds that invest in everything from real estate to micro-cap stocks) has achieved a 12.26% annualized return, net of its 1.5% management fee and 15% performance fee, since Hughes launched it in May 2005. In comparison, the MSCI World Index was up only an annualized 4.04% in the same period. He prefers to measure his success against the world benchmark because, by outperforming, Tosca Opportunity “takes away the worry of where to allocate” for its global clientele. He also has outdistanced U.K. equity benchmarks. During the first nine months of 2016, Tosca Opportunity actually got a boost from Brexit, delivering a 12.35% net return, compared with just 2.28% for the MSCI.

The hedge fund looks for profitable companies in misunderstood industries. Hughes is especially partial to commercial and residential construction outfits such as Redrow (ticker: RDW.UK) that temporarily lost a big part of their valuation in the panic following the Brexit vote in late June.

Tosca Opportunity tends toward companies’ enjoying favorable secular trends. For instance, it has snapped up shares of auto insurers, including esure Group (ESUR.UK), because, as Hughes notes, the number of cars on U.K. roads hasn’t declined on an annual basis in 20 years. He also likes global corporate-services companies, such as Luxembourg-based Regus (RGU.UK), which serves the “Google economy” by renting full-service offices on short-term leases, and San Francisco–based RhythmOne(RTHM.UK), which provides mobile apps for advertisers.

A talented management group with a substantial equity stake is another attraction for Tosca Opportunity. About 70% of the fund is in companies whose founders are still the largest shareholders and have an established track record. Hughes invests alongside the founders by buying large equity stakes—sometimes more than a third of the shares. This gives him the influence, he says, to “work quietly behind the scenes providing supportive business advice” to executives to take shareholder-friendly actions.

Esure checks a lot of the boxes of a Tosca Opportunity investment. It’s 31% owned by founder Peter Wood. Esure also announced in September that it will break into two companies–an auto and home insurer and an online price-comparison business called Gocompare.com—that Hughes contends “are worth more than the current whole” because each segment is rapidly gaining market share.

About one-third of the companies that Tosca Opportunity has owned over the past decade have been involved in mergers, acquisitions, or “disposals” of one sort or another. Ideally, however, Hughes says he would rather hold onto a company and wait for its stock to rise. “We’d rather let the market get it right,” he observes.

THE FUND FIRST invested in esure in January 2010, when it was still private. But esure went public in March 2013 and its stock has been mostly out of favor since, recently trading within a couple of pennies of its IPO price of 290 pence ($3.54). Investors soured on the shares because insurance rates fell and earnings tumbled following the initial offering. More recently, however, rates have begun to rise and Hughes expects analysts from brokerages to take more note as the breakup approaches.

Similarly, he sees more attention and a re-rating coming for Redrow, the residential construction company that was whacked by Brexit, which knocked about a third off its share price. Even after recovering all the losses, the stock trades at just seven times forward earnings, while peers fetch about 10 times. Redrow’s profits have grown 22% this year as sales have climbed, and he sees similar gains next year as volume rises. All told, Hughes’ investment in Redrow has nearly doubled since his first purchase in February 2008, when the global stock market was reeling.

While 75% of the fund’s net asset value comes from companies that make their money in the British Isles, RhythmOne is an exception. It started life in London in 2004, but moved its headquarters to San Francisco. RhythmOne creates software that allows companies to market their wares directly to consumers via mobile devices. RhythmOne’s share price plunged by nearly 90% from late November 2013 through mid-2014 as investors feared its planned shift from PC-based software delivery to mobile apps would trigger short-term losses. The investors were correct over the past two years.

Hughes was able to snap up RhythmOne’s shares for about 30 pence apiece in April 2015, when the troubled company had about 80% of its market capitalization in net cash—a soft cushion for even the worst-case scenario. RhythmOne has made two acquisitions, and Hughes thinks it too will merit a re-evaluation, as analysts begin to factor in these added revenues.

“We buy on problems only when we think we’ve got the solution,” says Hughes.

THE FUND NOT ONLY WORKS closely with entrepreneurs, but also with its own network of clients. Most investors who make a two-year commitment to the fund are rewarded with a lower management fee of 1% and a lower performance fee of 10%. Another perk: “club deals,” in which investors can buy stock directly in some companies the fund owns, including privately held Mabec Property, a real estate developer, and San Leon Energy (SLE.UK), a global oil and gas company based in Ireland.

“If there is a deal, Martin will come to us and say, ‘Would you like a piece of it?’ ” says investor Dineen, who put money into Tosca Opportunity at its inception in 2005. “He is on very good terms with his key investors.”

No doubt, some of these investors are rattled by Brexit and the many uncertainties it’s created. But Hughes can take some satisfaction in the market’s strong rebound and subsequent gains in consumer confidence. He’s convinced it will be a boon to the types of U.K.-based and domestically focused companies he favors.

In the months to come, the investment manager expects the value of his holdings to grow, at least in sterling terms, as Britain goes its own way. Well-run U.K. companies should see their efforts—and their shareholders—rewarded.

Swiss luxury watch and jewelry maker Richemont could soon recover some of its sparkle after being battered in recent quarters by sluggish Asia demand, volatile currencies, and weakening tourism in Europe.

The grandly named Compagnie Financiere Richemont (ticker: CFR.Switzerland), which counts Cartier, Piaget, Lancel, and Montblanc among its many brands, issued a profit warning last month after sales in the five months through August plunged 14%. It reckons that operating profit in its fiscal first half to the end of September, due to be reported Nov. 4, will be 45% below the level in the same period last year.

The problems afflicting Richemont are occurring across the sector. Few luxury businesses have been spared by slowing economic growth in Asia, where much of their clientele is based, or an anticorruption crackdown in China that targeted gift-giving. Struggling economies across Europe have also taken a toll, and a recent spate of terror attacks has deterred many tourists, particularly in the key French luxury market.

U.K.-based Polar Capital fund manager Nick Davis says Richemont has most of the characteristics he looks for in a stock. “We like to buy good companies when they’re out of favor, and that’s certainly true of Richemont,” he observes.

Richemont’s only homegrown problem is the Swiss franc, which remains strong after the country removed a cap on its value against the euro last year. As a result, Swiss companies’ repatriated international earnings have come under pressure.

THERE WERE SOME BRIGHT spots in Richemont’s September update. The company boosted sales in China and South Korea, while Britain’s decision to leave the European Union and the consequent weakening of the pound helped lift its revenue there. Richemont’s management held its nerve during the worst of the market downturn and didn’t succumb to the temptation to pursue short-term profit, either by cutting back on advertising and promotion spending or slashing prices. In fact it did the opposite, even to the extent of buying back excess inventory.

Richemont was helped in this by shareholders who support its long-term strategy. “You can damage these brands very quickly and it takes a long, long time to recover,” Davis comments.

Davis also makes a distinction between so-called hard luxury goods, which include watches and jewelry, and soft luxury, such as fashion. Hard luxury has more sustainable earnings and is protected by very high barriers to entry.

Within this group, Davis believes Richemont is well positioned to benefit from a recovery, despite current soft market conditions. He describes the company as “one of Europe’s true global champions,” with China counting for more than 20% of its overall sales and