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WHEN: Today, Wednesday, July 18th
WHERE: CNBC Institutional Investor Delivering Alpha Conference
Following is the unofficial transcript of a CNBC EXCLUSIVE interview with Edgar Wachenheim III, Greenhaven Associates Founder, Chief Executive Officer and Chairman, live from the CNBC Institutional Investor Delivering Alpha Conference in New York City on Wednesday, July 18th.
Mandatory credit: CNBC Institutional Investor Delivering Alpha Conference.
JIM CRAMER: Thank you so much, Ed, for coming on. Ed wrote "Common Stocks and Common Sense," which is a terrific book for if you want to try to figure out if there's stocks --
EDGAR WACHENHEIM: Value stocks.
JIM CRAMER: Okay. So I pick up this morning's paper in the Business Day section of "The New York Times," and the headline is: A Ho-Hum Change for Goldman. And then a discussion that Lloyd Blankfein is saying to Solomon: I would say that the consumer business has moved to us. It's become mathy, algorithmic, platform, distribution, digital, all the things we've been historically good at. Is that what we want from Goldman? You like Goldman Sachs. Is Goldman going the right way? And does it matter who runs Goldman or not?
EDGAR WACHENHEIM: Well, I think the bench is so deep at Goldman in terms of the management, they probably have hundreds of people that could lead a firm. I mean, they get the best and the brightest, maybe 100, 200 young, bright people each year into the firm. Some leave and some stay, but they've got tremendous depth, which is one of the reasons we like the firm. I like what they're doing in terms of Marcus and what they're doing in terms of technology, because they're experimenting. It's good to take some money and put it into a new area. And if it works, fine; if it doesn't work, they go on and do something else. They're not old and stodgy and just doing the old investment banking and the old market-making. I think it's a positive that they're somewhat innovative at this particular time.
JIM CRAMER: Because as a value player, you need to see -- have others see the value that you do in order for the stock to go higher. Book value of $197 for what was -- I always thought the premier investment bank -- a nine multiple. These are things that I don't understand. Can you explain to me how Goldman became a value stock and whether it should be considered a stock of higher value or a growth stock? What is the market missing as a paradigm for the kind of investment?
EDGAR WACHENHEIM: So it's betterment. Its betterment can change. So let's start out with the earning power. I think this year, they've earned just a little under $13 in the first six months, it's sort of a $26 annual rate. There are some recurring things in there. But they're doing well. I think a couple years down the road, their earning power is in the high 20s -- $27, $28, $29 per share, which would be about a 15% ROE. We use tangible books.
JIM CRAMER: Right.
EDGAR WACHENHEIM: So we use $183 as book value, not the $190 I think that he used. If you think about what it's worth, I would take the investment banking business and put a very, very high multiple on it. I would do sort of an analysis, making the company --
JIM CRAMER: I agree. Yesterday, the news commentary was that investment banking is not the business to be in. David Solomon ran -- when I worked at Goldman, you were second-rate if you weren't investment banking. It's always been like that. The commentary is so wrong. That's the money division.
EDGAR WACHENHEIM: It earns about $7.50 a share, if you want to take the 26, 27; and it's probably worth 18, 19, 20 times the earnings. You know, the average stock sells -- historically, it's 16 times earnings; this certainly is better than average. So when you take the investment management business, I happen to feel -- I'm sorry, I hope there's no Goldman people in the audience -- but I happen to feel they don't do a very good job at it. But it's a high return business, maybe worth 15, 16, 17 times the earnings. But the market-making is only worth 10 times the earnings. I could make the case that the company's worth 12 or 13 times the earnings. And if you put a 13 multiple on -- someday it will be -- our government uses simple arithmetic --
JIM CRAMER: Right.
EDGAR WACHENHEIM: -- $30 a share of earnings, which may not be in two years, at $30, it may be in 2021 -- you have a stock that sells roughly at $400, and it's $230 today.
JIM CRAMER: And your performance speaks for itself. What people should recognize is that that's actually not a long time at all in your world.
EDGAR WACHENHEIM: We look out two or three years.
JIM CRAMER: Right. So Goldman's worth holding, if it can get there. Buy it right here, and you certainly could expect it to shift --
EDGAR WACHENHEIM: $230 to, I think, about -- I'd say about $400. It would be 13 times 30. It would be close to $400.
JIM CRAMER: Right. So when is Michael Corbat going to get respect for a company where he is buying back -- at these prices, he could buy back 10% of the company this year. The numbers were quite fine. Stock was up much higher. I know you regard this as being one of the great value stocks in finance.
EDGAR WACHENHEIM: I can't cross that in the -- all I can do is buy stocks that I think are deeply undervalued. And the numbers on -- I think were pretty clear. They had their meeting about a year ago, in July of last year. And they projected $9 a share of earnings for 2020. Now, we don't just take that as God-send. You should never ask your barber if you need a haircut. So we do our own analysis. And, you know, $2 of that comes from share repurchases. You mentioned they're buying back about 10% of their stock this year, $17.6 million worth. They've announced that they expect to buy back and pay a dividend of about $60 billion in three years. That's on schedule. Part of the increase is interest rates, part of it is cost-cutting, part of it is growth; and they are soon to be on target. That $9 a share was based on the old tax rate. And if you increment it to the new tax rate, it's about $10.20. So just say that Citigroup owns -- earns, I'm sorry, about $10 a share in 2020. Now you've got to put a multiple on it. Now we've got to put a multiple on it. Some of their businesses are really good. They've got trade -- Treasury and Trade Solutions.
JIM CRAMER: Makes money every day, regardless.
EDGAR WACHENHEIM: It's a very good business. They and JP Morgan dominate it. It's a very high-return business. That's worth more than 16 times the earnings. They've got in a very good investment banking business that earns over $1 a share. They have a very strong business in -- all I could do is say, take the different businesses within Citigroup and come to some conclusion of what it's worth, and that would also come out to about 13 times earnings. So it would be a $130 stock on a $70 today. And I can't call the sentiment, Jim.
JIM CRAMER: Right.
EDGAR WACHENHEIM: And I've seen times when the sentiment is visible on a company, and then it changes; and a year or two later, the stock goes up twice or three-fold of what it was. I'll give one example on that, which is Boeing. In February of 2016, Boeing was selling at $120 a share. We estimated it would earn $10 that year. And in 2018, because we were looking two years out, they were going to earn about $12 a share. So Boeing, in our opinion, a great company, with great management, strong balance sheet, more cash than debt, a duopoly in the world, was selling at ten times two years out earnings. The sentiment around the company was negative because it was fear that the dual allow () airplanes had peaked out in terms of orders and may even lose some backlog. Delta, as you may remember, had tried to sell its '07, and they sold it for a very low price.
JIM CRAMER: Right.
EDGAR WACHENHEIM: The thesis was, uh-oh, there's a huge, huge market -- huge, huge market for 777s. And people that have them backlogged will cancel the backlog and buy a used plane, and the backlog will collapse, and that was the sentiment. A year and a half later, the stock had doubled, and now their stock is selling at three times what it did in February of '15. So the sentiment can change.
JIM CRAMER: It's interesting. These bank stocks that we're talking about peaked January 30 from the ten year. They were supposed to be going to 3.25 for three. Now we all figure ten years going to 2.6; Jeff Gundlach saying that this weekend. These are things that you cannot focus on, correct?
EDGAR WACHENHEIM: I can't focus on the sentiment -- okay. So I could focus on earnings two or three years out. I can't call four or five years out because there's too many variables.
JIM CRAMER: Right.
EDGAR WACHENHEIM: And I can focus on what the stock should sell at. And, then, we'll hit it with the number of stocks, we hit it with Boeing; and then we'll miss it with some stocks.
JIM CRAMER: What happened, when the re-rating occurred, it was a freight train. I mean, it wasn't like it suddenly decided -- people said, well, you know what? I'll buy a little Boeing. I mean, Boeing just shot right through 200 different --
EDGAR WACHENHEIM: 200 points, as a minimum. The negative reports on Wall Street turned it into neutral reports, then it was positive reports, and very positive reports, and the stock keeps going, yes.
JIM CRAMER: This, to me, brings us to the autos. Because here's a group -- I do a lot of work on Ford. You know, the CEO -- it's a steel cage. People say, What does he know, steel cage? It's furniture coming. You've got a company that historically didn't seem to mind losing money whatever part of the world it was; a company that said even though they are dominate in pickups, they should be in sedans. What do people not see that you are about to tell us about the new Ford?
EDGAR WACHENHEIM: Well, can I correct you on something?
JIM CRAMER: Sure.
EDGAR WACHENHEIM: You said the autos. I consider it a truck company.
JIM CRAMER: Not an automobile company?
EDGAR WACHENHEIM: That is the big difference.
JIM CRAMER: Right.
EDGAR WACHENHEIM: Ford and General Motors both earn about two-thirds of their money from trucks. When I say "trucks," I'm talking about pickup trucks, particularly full-size pickup trucks, vans, and very large SUVs that are on the truck frame. That, I'll just put it in perspective, is about $65 billion of revenues for Ford, out of $158 billion total last year. And it's about two-thirds their profits. And just to put the rest in perspective --
JIM CRAMER: Two-thirds of their profits?
EDGAR WACHENHEIM: Profits, yeah. They actually -- they put out a bubble chart at the end of the first-quarter earnings, and the bubble chart had $90 billion of revenues at a 16% margin. In that 90 billion of revenues was about $65 billion of truck revenues. And if you work out, that has to be about a 16% margin. The rest of it was the financial theory on China, and maybe the Mustang. So we pretty much know what they earn in trucks, and General Motors said they earn about the same as Ford does. So these heavily are truck companies. Just in rough terms, round it off, Ford earns about 65% of its money in trucks; maybe 10% in China; about 20% in Ford Credit, their financial subsidiary; and maybe 5% in cars and SUVs. As you know, they're getting out of cars in North America, except for the Mustang. So the companies are considered automobile companies, but they're really truck companies. Now, the automobile business, in my opinion, is a poor business. It's a monetized -- all over the world, profits are lower, except for luxury vehicles. The pickup truck business in particular, in my opinion, is a very good business. It is largely a North American business because in Europe and Japan, in the urban areas, it is hard to drive or park a truck. You would not want to park a truck in Tokyo. They are much less fuel-efficient, and gasoline is expensive in Europe and Japan. So it's been a North American market. The large share of pickup trucks basically are not made outside of North America. And in North America, the big three still dominate: Ford has about 38% share, General Motors has about a 38% share, then there's Dodge. And then Toyota did try and break into the market. They opened a plant in Texas, and they've never been very successful. The American companies have a 92% share. So with all these advantages and tremendous brand loyalty, which you tend to find in trucks compared to cars, and the type of person buying a pickup truck tends to be more nationalist and pro-American than somebody who buys a car, particularly the ones that buy cars on the east coast and the west coast, you have a consumer or a business -- a product that has a brand name and has pricing power and earns about 16% margin. It's a very good business.
JIM CRAMER: All right. So in 2011, the stock trades at 18, it's been going down ever since. Why do we believe that the Ford family, which had been committed to not necessarily focusing on profit, is suddenly going to understand that it is high, and that they have to stop making cars around the world that aren't making money, focus on this profit. Or have they already, and we just aren't going to know until --
EDGAR WACHENHEIM: I think I have an answer.
JIM CRAMER: Okay.
EDGAR WACHENHEIM: Bill Ford, who is the Chairman, is the great-grandson of Henry Ford. There are a lot of great-grandchildren. They own 88 million B shares, which, if you divide by all the number of Ford family members, is not a lot of stock per Ford family member. They need income. So that's one reason why Ford pays a 60 cent dividend, regular and paid --
JIM CRAMER: The yield.
EDGAR WACHENHEIM: So the stock is 11, so it's even more than that today. So they need income. And they need diversification. So if they can pay large dividends out, they can take some of the money, not spend it, and buy something else besides. And I think they are driven to do that. That is why Bill Ford changed management in May of last year and brought in Jim Hackett, in my opinion. And Jim Hackett, basically works for the company -- and this is one of the reasons we like Ford -- and said, the $90 billion that I talked about of very good products, they earned about a 16% margin, are great. Then they have about $28 billion of products, some marginal profit, and then they have $40 billion of products including North American cars, European cars, Brazil, India, the far east, some other countries, that basically -- they say it's worth about $4.5 billion pre-tax last year. If they could cut out those losses, which I think management wants to do, last year, they earned $1.78 per share. Those losses are equivalent of 80 to 90 cents a share. So if they could get rid of the losses, the company is earning $2.50 a share of earrings. It's just simple arithmetic. I like to keep things simple.
JIM CRAMER: Right, right.
EDGAR WACHENHEIM: And they will be two-thirds of a, at that point, truck company. A car company may be worth five times earnings. But I think a truck business is at least an average business in the United States, probably better than average. The average P/E ratio of stocks over a 50-year period of time in the United States has been about 16 times the earnings. So if you give the truck business two-thirds of its 16 times earnings, I'll give the rest -- I'll give the credit business, the China business that has some political risk to it, I'll give the automobile business 5 times, 6, 7, 8. You could say that the company's worth, let's say, 12, 12 and a half times earnings. And if you put a 12 and a half multiple on 2.50, you get $30 a share.
JIM CRAMER: Yeah, that would be --
EDGAR WACHENHEIM: It's nearly triple.
JIM CRAMER: And you're willing to wait how long for this to occur?
EDGAR WACHENHEIM: Well, for triple? I'm willing to wait a long period of time. I think the company's going to help, because I think they're frustrated. They called an analyst meeting for September. I don't think Jim Hackett would call a meeting in September unless he had a lot to talk about. And he has talked publicly, with a sense of urgency, to cut the losses and, furthermore, even to improve the businesses that already are doing reasonably well. So they have a multi-billion-dollar efficiency program, and they have done such things as say they're getting out of North American cars. I think it's now a lot more to eliminate the losses.
JIM CRAMER: And not too late to buy General Motors, if you're kind of, from low 30s.
EDGAR WACHENHEIM: Well, the stock's supporting it. And they're earning $6.50 per share this year. And this year's being held back because they're coming out with a new line of pickup trucks. And that is -- the delta on that from plants closing temporarily is $900 million of lost profit. This year, they should get back. Next year, they should reorganize Korea. They should pick up about 400 to 500 million dollars; some this year, some next. They've got a cost-efficiency program, which will help earnings next year. They're buying back stock, 4 or 5%, so up per year; so in two years, let's say it's up 10%. If you do the arithmetic, that adds 50 or 60 cents a share. So you can make the case that in a reasonable environment, that General Motors can earn about $8 a share in two years. And, again, I would put the same multiple on with the same arithmetic. And General Motors, 65% of the earnings roughly again will come from trucks; in their case, 20% from China, about 10% from GM Finance, and about 5% from cars and SUVs outside of --
JIM CRAMER: Do you follow the trade and tariff? Like, for instance, Larry Kudlow this morning saying China going poorly, does that make you say, well, listen maybe the upside is capped?
EDGAR WACHENHEIM: You know, you never know what's going to happen. In any of these situations, we look at a company, there are many, many, many variables. And it's hard for me to identify all those variables. If I could identify them, to analyze them, to weigh them, to know it's discounted into the price of the shares already, and then there will be a new variable that comes along two or three years later. So we do not pay attention to these near-term fundamentals in terms of a trade or in terms of what interest rates are going to do. You know, over a long period of time, you've had hiccups in the stock market. Every time the stock market has gone down, it's then gone back up and then reached new highs. Even the worst hiccups that we've had. We've had a lot of other scares. In early 2016, when the price of crude hit $26 a barrel and we were going to have a crisis because big oil companies were going to go bankrupt, it's going to hit the banks and it's going to travel throughout the world. Saudi Arabia was going to have a range of problems. These things all pass. We're talking about tariffs today. It's a major source of talk at this particular conference, and maybe a year or two from now it won't even be on the agenda.
JIM CRAMER: Fair enough. I want go into housing. But Stuart Miller, we both know, is fantastic. I knew his father, Leonard, who built the company as Lennar. Overall, the housing market has remained strong, seems to continue to strengthen. Even with questions about rising interest rates, labor shortages, rising construction costs, macro international pay attention to housing markets being resilient, talks about a general sense of optimism about the market, unemployment a record low, and dual income-producing family resurgent, millennial population forming households. And yet this group can't get out of its own way, because all we hear about is mortgage rates.
EDGAR WACHENHEIM: It's mortgage rates.
JIM CRAMER: Is this the time to look at a Lennar, to look at a Horton?
EDGAR WACHENHEIM: Yeah, let's discuss, I think the stocks are down, they're probably down 10 or 15% this year because of interest rates. They came back a little bit yesterday. And let's analyze affordability, which is the issue of mortgage rates. The mortgage rates today are roughly 4.5%. Normally they're 6%. So they're still below normal. When you look at the reasons to buy a house, interest rates, which are mortgage rates, are one; but then there's the economy, which you mentioned; there's the outlook for the economy, which is confidence; there's the price of houses, because people will hold -- sometimes leaving an existing house to buy a new house. So there are many, many other considerations, and most of the other are more favorable. The other major consideration is, people have to live somewhere. You just -- you know, you get married, you have a child, you can't live in the street, and you certainly don't want to probably live with your mother-in-law very long, so you've got to live somewhere. So the basic demand for houses, we think, and Harvard thinks this in their annual study, is about 1.5 million housing units per year, is normal. And we're now producing 1.3. So on the basis that somebody has to live somewhere, we think we'll move up to 1.5, or we're moving in that direction. But there's one other very interesting number when we got on mortgage rates, because we did some work on it. In the 1980s and 1990s, the 30-year mortgage rate averaged 10.4%. And with 10.4% 30-year rates, an average of 1.4 million houses were built each year in the United States during that 20-year period. And the population of the United States was 250 million? Right, 250 million. And the population now is 325 million. So if your population adjusts to 1.4 million, in today's population, it's 1.8 million housing starts per year. We only want 1.5 million. So it's a consideration, but there are many other considerations.
JIM CRAMER: But sometimes when I listen, I think, look, these are living, breathing companies. Lennar is run by -- well, Stuart is moving up. Doug Yearley at Toll, these are unbelievable operators. They're act -- they act as if they're just plain vanilla and the only real operators are Jeff Bezos and Zuckerberg. These are really good businesspeople. It just seems like that no one wants to give them credit for putting together -- Stuart's made some great acquisitions. Toll's made some great acquisitions. These aren't the same companies they were five years ago.
EDGAR WACHENHEIM: Well, you just said something. They're not the same companies, and let me go into that a little bit. I absolutely agree with you, they're just out of favor. And they're out of favor -- it's the reason I want to be up here today to talk about it. If all my stocks are in favor, I would say no, no, I'm going to pass and I don't want to talk about stocks that are already up. So that's the reason I'm here. So there's another major change in the industry, which is even more important, in my opinion, than the fact that housing starts are going from about 1.3 million to 1.5 million. And because we've been underbuilding for 30 years, they may go more than 1.5 million. But we base earnings on normality, and normal is 1.5 million. What's happened is, if you go back three, four, five years ago, housing companies took the profits and reinvested them in land, because they wanted to own the land to grow. That was a poor investment, number one, because land appreciates 2, 3, 4% per year, so they were getting a 2 or 3 or 4% return on their money. Not very good. The second consideration was if they're taking their cash flow and reinvesting on land, what's left for the shareholders? So this, in my opinion, led to home builders not being a very good business. I would say they're a fair business. I wouldn't say they're a poor business, but they're a fair business. There was one company, NVR, that was an exception to the rule, and still is an exception to the rule. And NVR is asset-light. They only buy land about a year or two before they need it. So they take a large percentage of their cash flow, instead of tying it up in land, and return it to the shareholder. And they buy back typically, 4, 5, 6% of their shares each year, which the home builders never do. In NVR, P/E ratio has typically been 16 to 17 times earnings. Today it's 16 times earnings. It's 16.1 times earnings. I looked it up this morning, because I knew the subject may come up. The other home builders are typically sold at 10, 11, 12, 13 times earnings. Now, the other home builders have seen this, and they are becoming asset lighter. And it's a major, major fundamental change in the industry, which I don't think has been picked up.
JIM CRAMER: Not at all.
EDGAR WACHENHEIM: The numbers are staggering. So Horton not is only carrying less land on their books, but they are going 60% option land and 40% purchase land, which makes them much less asset-light because they're optioning so much land as apposed to buying it. And then they bought 75% interest in a company called Forestar, which is a developer of land. So Forestar will develop land for Horton off the balance sheet. So they are becoming asset-light. Horton is generating $800 million of free cash flow this year for the shareholders. They're reducing debt, but at some point they'll make acquisitions, they'll buy back stock. And the projection is $1.25 billion of free cash flow for 2020. Lennar is doing the same thing.
JIM CRAMER: Right.
EDGAR WACHENHEIM: And their projection is $6 billion -- Stuart Miller will say this -- of free cash flow over the next three years. These are enormous -- a complete change. And instead of selling at 11, 12, 13 times earnings, in my opinion, these companies deserve to sell closer to the NVR, 16 to 17 times earnings. That's a major change.
JIM CRAMER: I want to thank you. It is a delight to not have to talk about infinite P/E, and you talk about companies that if anyone did homework would recognize that there's dramatic change. And you do your more homework than anyone. Ed Wachenheim, thank you so much for coming.
EDGAR WACHENHEIM: My pleasure. Totally my pleasure.
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