Heartland Value Plus Fund 2Q17 Portfolio Manager Commentary

Executive Summary

  • Stock selection was mixed with Financials and Health Care holdings leading on the upside, but the Fund lagged its benchmark, the Russell 2000® Value Index, returning -1.04% versus 0.67%.
  • Investors sought to maintain momentum of the equity markets by focusing on bond proxies, perceived safe havens, and companies with potential top-line growth.
  • The economic uncertainty felt on Wall Street seemed in contrast to the outlook of many business owners across the country. 

Second Quarter Market Discussion

Political discord in Washington hit a feverish pitch, and skepticism grew that a tax overhaul, infrastructure spending, and regulatory relief will materialize in the near term. With hopes of a corresponding reflation trade on hold, investors sought to maintain momentum in the equity markets by focusing on bond proxies, perceived safe havens and companies with potential top-line growth. The approach drove the major indexes to new highs and provided a tailwind to some larger names.

The economic uncertainty felt on Wall Street was in stark contrast to the outlook of business owners across the country. As shown, small business optimism hit a recent high. The survey results are consistent with the general upbeat sentiment we’ve observed in meetings with management teams of the businesses we own. 

Great Expectations

Heartland Value Plus Fund Portfolio Manager Commentary Small Business Optimism Chart

Source: Bloomberg L.P., 3/31/2007 to 5/31/2017
Economic predictions are based on estimates and subject to change. All indexes are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

Attribution Analysis

Security selection was mixed with Financials and Health Care holdings leading the way on the upside. Our stocks in Utilities and Information Technology (IT) lagged on a relative basis, and the Fund trailed its benchmark, the Russell 2000® Value Index. An overweight to Energy was a key detractor during the quarter. Our holdings in Industrials hurt relative results, but an overweight to the group offset some off the weakness.

Heartland Advisors value investing portfolio commentary financials sector iconCash is king. Our Financials holdings boosted results and contained a top contributor. First Cash Financial Services, Inc. (FCFS), which operates pawn stores in the U.S. and Latin America, was up sharply after it posted better than expected results driven by cost cutting and a strengthening peso.

We remain constructive on the company and believe it can grow earnings by opening more locations in Latin America, and leveraging its existing cost structure.

Heartland Advisors value investing portfolio commentary materials sector iconPainted with a macro brush. Expectations of slowing growth weighed on Materials. The Fund’s holdings in the sector were up and outperformed those in the Index.  We continue to see names with improving margins and results.

Schnitzer Steel Industries, Inc. (SCHN) was up strongly after reporting strong earnings growth on a year-over-year basis. Revenue from its autos, metals, and recycling (AMR) business were up 12% on greater volume and stronger pricing. Management remains focused on increasing its operating leverage while paying down debt.

The company is also integrating its steel manufacturing business with its AMR unit, which we believe will lead to greater production flexibility and cost savings.

Steel prices have begun to firm, and we expect them stabilize as demand increases. Schnitzer’s technological advantages over competitors—which allow the company to produce more cost-effectively— should result in greater benefits from an incremental gain in pricing. Additionally, the company has already reduced costs and should be able to drive additional efficiency in its operations.

With the stock trading at 6.0x enterprise value/earnings before interest, taxes, depreciation and amortization (EV/EBITDA), we believe the market isn’t fully valuing the company’s operating leverage and is too pessimistic on steel prices.

Heartland Advisors value investing portfolio commentary technology sector iconTactical defense. The Fund’s Information Technology names were off mildly on an absolute basis and lagged those in the benchmark. During the quarter, we initiated a new position in former holding ManTech International Corporation (MANT).

We had sold out of the government services company in January of this year after shares had appreciated due to strong results in the latter half of 2016. Since that time, ManTech’s stock has receded and the risk-reward balance, in our view, warranted re-entering the name.

We have long-been impressed with management’s capital allocation strategy and believe its focus on cyber services business will result in higher margins.  The business generates significant cash flow, which results in a free-cash-flow/enterprise value yield in excess of 7%. We believe the company is at an inflection point and strong business bookings in 2016 could result in mid-single digit revenue growth for 2017.

Portfolio Activity  

Regulatory relief may yet materialize, and we view Washington’s focus on improving the domestic business climate as an eventual tailwind for the economy. However, with the pace of change uncertain, we are focused on owning businesses that:

  1. have strong or improving balance sheets,
  2. are well positioned to expand operating margins through self-help initiatives, and
  3. are currently profitable.

Businesses with opportunities to reduce costs and improve margins through internally focused efforts should be able to capitalize on operating leverage in an expanding economy or modestly grow earnings should sales remain flat.

We’ve exited some holdings on recent strength and have redeployed assets into more attractively valued businesses in various industries. The result is a compact portfolio of approximately 50 names with nearly one-third of assets held in the 10 largest positions.

Heartland Value Plus Fund Portfolio Manager Commentary QuoteOutlook and Positioning

We believe a renewed interest in valuations and earnings prospects will be closely tied to improved clarity for the economy and the geopolitical backdrop. If the administration in Washington is able to deliver on expected regulatory relief, a further improvement of the business climate should materialize.

The strong run for equities and the length of the bull market has led some investors to question whether valuations have gotten ahead of themselves. The market as a whole appears fully valued, and bond-like sectors such as Real Estate Investment Trusts and Utilities have become even more challenging for valuation-sensitive investors. However, as bottom-up investors we are focused on the valuations and business prospects of individual names we hold as opposed to the price/earnings of a broad index.

Thank you for the opportunity to manage your capital.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Bradford A. Evans

Bradford A. Evans

Evans, CFA, is Senior Vice President and Portfolio Manager of the Value Plus Fund and its corresponding separately managed account strategy. He has 21 years of industry experience, 18 at Heartland.

Heartland Advisors Value Investing Research Analyst Andrew Fleming

Andrew J. Fleming

Fleming, CFA, is Vice President and Portfolio Manager of the Value Plus Fund and its corresponding separately managed account strategy. He has 8 years of industry experience, 5 at Heartland.

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In the prospectus (pdf) dated 5/1/2017, the gross expense ratios for the investor and institutional class of the Value Plus Fund are 1.19% and 0.97%, respectively. The Advisor has voluntarily agreed to waive fees and/or reimburse expenses with respect to the institutional class, to the extent necessary to maintain the institutional class “Net Annual Operating Expenses” at a ratio not to exceed 0.99% of average daily net assets. This voluntary waiver/reimbursement may be discontinued at any time. Without such waivers and/or reimbursements, total returns may have been lower.

Past performance does not guarantee future results. Performance represents past performance; current returns may be lower or higher. Performance information for institutional class shares of Funds that existed prior to their initial public offering is based on the performance of investor class shares. The investment return and principal value will fluctuate so that an investor's shares, when redeemed may be worth more or less than the original cost. All returns reflect reinvested dividends and capital gains distributions, but do not reflect the deduction of taxes that an investor would pay on distributions or redemptions. Subject to certain exceptions, shares of a Fund redeemed or exchanged within 10 days (90 days for the International Value Fund) of purchase are subject to a 2% redemption fee. Performance does not reflect this fee, which if deducted would reduce an individual's return.

An investor should consider the Funds’ investment objectives, risks, and charges and expenses carefully before investing or sending money. This and other important information may be found in the prospectus (pdf). To obtain a print prospectus, call 800-432-7856. Please read the prospectus carefully before investing.

Because of ongoing market volatility, performance may be subject to substantial short-term changes.

The statements and opinions expressed in the articles or appearances are those of the presenter. Any discussion of investments and investment strategies represents the presenters' views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. The specific securities discussed, which are intended to illustrate the advisor’s investment style, do not represent all of the securities purchased, sold, or recommended by the advisor for client accounts, and the reader should not assume that an investment in these securities was or would be profitable in the future. Certain security valuations and forward estimates are based on Heartland Advisors’ calculations. Any forecasts may not prove to be true.

Economic predictions are based on estimates and are subject to change.

There is no guarantee that a particular investment strategy will be successful.

As of 6/30/2017, First Cash Financial Services, Inc., Schnitzer Steel Industries, Inc., and ManTech International Corporation represented 3.41%, 2.80%, and 1.69% of the Value Plus Fund’s net assets, respectively. 

Portfolio holdings are subject to change without notice. Current and future portfolio holdings are subject to risk.

The Value Plus Fund invests in small companies that are generally less liquid and more volatile than large companies. The Fund also invests in a smaller number of stocks (generally 40 to 70) than the average mutual fund. The performance of these holdings generally will increase the volatility of the Fund’s returns.

Value investments are subject to the risk that their intrinsic value may not be recognized by the broad market.

Sector and industry classifications as determined by Heartland Advisors may reference data from sources such as FactSet Research Systems, Inc. or the Global Industry Classification Codes (GICS) developed by Standard & Poor’s and Morgan Stanley Capital International.

Heartland Advisors defines market cap ranges by the following indices: micro-cap by the Russell Microcap®, small-cap by the Russell 2000®, mid-cap by the Russell Midcap®, large-cap by the Russell Top 200®.

There is no assurance that dividend-paying stocks will mitigate volatility.

Heartland’s investing glossary provides definitions for several terms used on this page.

The above individuals are registered representatives of ALPS Distributors, Inc.

The Heartland Funds are distributed by ALPS Distributors, Inc.

Separately managed accounts and related investment advisory services are provided by Heartland Advisors, Inc., a federally registered investment advisor. ALPS Distributors, Inc., is not affiliated with Heartland Advisors, Inc.

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