Funds manager serves up plenty of food for thought

THREE decades ago, an accounting class at St Patrick's College in Ballarat was analysing the ins and outs of Cadbury Schweppes.

Funds manager Lee IaFrate remembers it well. Brother Murphy was the teacher and what IaFrate, then 17, learnt was that Cadburys was all about brands, strong brands.

The lesson has never left him. He is still buying shares in companies with strong food brands. Frequently, the companies are beaten up and friendless.

IaFrate runs Armytage private, a funds management company that looks after about $150 million in three funds.

A few years ago he made a small fortune selling out of the listed Treasury Group, which he founded. He sold his shares at $13, $15 and $16. They are now $7.73.

IaFrate is a small-cap man at heart, but most investors feel better with their money in big companies. So Armytage gives punters a bit of both, but with a slant to big companies.

"What we say to our investors is that 80% to 90% is in the leaders, but we've got this little spicy bit that the majority of the market isn't covering, which is small caps," he says. "We blend them into our fund hopefully to give us some outperformance."

After graduating from the School of Mines in Ballarat, IaFrate got a job in stockbroking, working for McKinley Wilson, where he researched small companies for institutions and rich private clients. He is still at it.

When it comes to small caps, he says: "You can get to know the companies better. You can understand the nature of the business a lot more quickly than the big companies where there are layers of people and spin doctors between you and chief executives."

When he worked in stockbroking, he was called the Cadbury Kid because he kept buying the stock for clients.

"The thing we learnt was that it was a very simple business to understand," he says. "They made chocolate and they sold it and they were a dominant player in the marketplace.

"You didn't have to worry about it and at some point the parent company was going to come back and privatise it. It did and everyone made money."

IaFrate's obsession with brands sounds a bit like Warren Buffett and his love of names such as Coca-Cola. But IaFrate is a rare beast when it comes to Buffett. "I'm not a great student or a follower of his process," he says. "If I read about another fund manager that says he's a Buffett ideologue, well, it's just boring. Come up with your own ideas, establish your own identity."

So how does he analyse companies, particularly those of the smaller variety?

"We start off with who's the natural owner of the business," he says. "Are the assets big enough and strong enough that somebody else could own them and do something better with them? We focus on the value of the business, its assets."

He also looks closely at the prices at which takeovers have been pitched. He then compares those values with the particular listed company he's looking at.

IaFrate has made money out of a string of takeovers in the food industry, including the bid for the company that made King Island cheese.

"We copped a lot of st from people and they used to laugh about us buying King Island shares," he recalls. "I said, 'son, you can't replicate the products that they've got and at some point that will be recognised'; and it was, with a very substantial takeover from National Foods, and they in turn were taken over."

So where does he put that philosophy into practice nowadays? "I'll give you a good example of what Armytage is a big shareholder in, it's called Patties Foods," he says. "They own Four'N Twenty pies, Herbert Adams, Patties and Creative Gourmet and Chefs Pride. "If you go into a supermarket (he regularly checks this out in his local supermarket) they have about 50% to 60% of the frozen savoury section of the shelves and about 30% to 40% of what they call the frozen dessert market. Nanna's and all that sort of stuff.

''You can't replicate those brands - they're the Coca-Cola of the savoury sector - and you can't replicate that market share. Their balance sheet is solid and their business is absolutely beautiful.

"It was a stock that was right in our space. We love the food sector and when they got belted around, it was good news for us. Bad news is good news for us."

He comes back to brands again: "A very good retailer told me once that when shoppers buy generic brands they put them at the bottom of the trolley so other people won't see them. They're happy to buy a generic Glad Wrap, but, when it comes to foodstuffs, they would prefer to buy Four'N Twenty, and pay more because they know what they've got.

"We look to see who the natural owner is and Patties is a classic stock that will be taken over by a major. Those sort of stocks will disappear. It's the law of the jungle, the big keep getting bigger."

Patties has fallen from $2.30 to 89, but IaFrate says he is unconcerned that it has fallen about 15% since he bought it.

"No, I'm not worried because the fundamentals are just so compelling," he says. "For example, it's on a forward price-earnings multiple of 7.8 and fully franked yield of 8.2%."

When it comes to the general market, IaFrate says it is about as vicious as anything he has seen in 25 years. "The small caps traditionally cop it the hardest and they're always the last to recover," he says. "The micro-caps are worse than syphilis at the moment."

His major fund was down 10% for the June year, compared with a near 13% fall for the relevant index.

But he is bullish. And he has been buying stocks that are sensitive to a turn in US sentiment such as News Corp and Billabong as well as out-of-favour stocks where there could be takeover activity such as Foster's, Tatts and Suncorp.

"It's been death by a thousand cuts that we've gone through in the last six to eight months, but we're past the worst," he says. "I always see the glass as half-full. If we're three to six months before the pack, good luck.

"Our view is that we're well and truly past the worst, the morose part of the market. We took the view in May that the markets were starting to bottom out and all of the trends that we were anticipating are now well and truly evident."

He says 90-day bank bill future rates are down, the oil price is coming down, the $A is falling and the Reserve Bank will have to cut interest rates.

He hopes Barack Obama will be the next US president and that he will be looking inwards rather than outwards.

"If that consumer economy starts to be given some positive sentiment, which it hasn't had for the past six to seven years because of the fellow that's there at the moment, that economy is going to turn," he says. "You can't have the biggest economy in the world floundering the way it is.

"Our view is that it is going to turn and when that starts to take shape, markets will recover quite strongly."