Heartland Opportunistic Value Equity Strategy 3Q16 Portfolio Manager Commentary

Executive Summary

  • While strong stock selection in a majority of Sectors boosted performance, weakness in Consumer Staples and Health Care detracted and the Strategy performed in line with its benchmark, returning 3.45%† vs. 3.87% for the Russell 3000® Value Index.
  • Improving economic sentiment helped lead cyclical sectors higher.
  • We continue to focus on names with strong balance sheets and consistent revenue.

Third Quarter Market Discussion

Major indexes built on last quarter’s move higher. Strength in the Russell 3000® Value Index was broad with nine of 11 sectors positive, as shown. Areas such as Information Technology and Financials were strongest, and yield plays such as Utilities lagged. The mix highlighted moderate optimism.

Broad Strength

Heartland Opportunistic Value Equity Strategy Portfolio Manager Commentary Sector Returns Chart

Source: FactSet Research Systems, Inc., 7/1/2016 to 9/30/2016
Past performance does not guarantee future results.

Sentiment toward U.S. and global economies inched up and helped lead cyclicals higher. With recession fears fading, defensive areas lagged. While no glaring pitfalls appeared on the economic horizon, investors focused on valuations as they sought to hedge unforeseen risks. We believe the search for attractive multiples boosted smaller companies, which have trailed for much of the past 18 months.

Attribution Analysis

Security selection was mixed. Financial holdings were a key source of strength along with names in Materials. The portfolio’s Consumer Staples and Health Care names lagged. The majority of our holdings in Industrials were up and the group contained one of our top contributors. Performance among the portfolio’s smaller names hurt results.

Standout on defense. Oshkosh Corporation (OSK) was up after it announced earnings that beat Street estimates and raised full year guidance. The majority of its business lines posted double-digit revenue growth and strong margin expansion. The company trades at 16x estimated 2017 earnings versus a median of 19x for peers. Price appreciation has nudged valuations higher, but we expect earnings will continue to improve. A ramp up in deliveries of mine resistant defense vehicles should provide revenue growth for the coming year, followed in 2018 by increased sales of light joint tactical vehicles. The company’s lift equipment unit has been under pressure but we believe sales have troughed and inventory management will offset some of the softness. 

A tank half full. Not all Industrial names were strong, however. Kirby Corporation (KEX) was down after it reduced guidance for the quarter and full year. The largest inland barge operator in the country cited depressed utilization rates for its tankers and a slower than expected recovery in the Energy sector. We remain committed to the company and anticipate inland barge pricing will firm in the second half as the petrochemical industry scales up due to low natural gas prices.

Good information. The portfolio’s Information Technology (IT) holdings were up on an absolute basis, led by a standout in network computing.

Top 10 holding Cisco Systems (CSCO) was a key contributor. The company unveiled details of a restructuring plan that calls for cutting costs from lower-margin lines and redeploying the savings into more profitable businesses, including security, next generation data centers, and cloud computing. Shares drifted lower after the announcement but were up for the quarter as its margins continue to hold up better than the market anticipated. We expect the improved perception of the company will continue.

With a free cash flow to enterprise value yield greater than 10% and low-debt balance sheet, we believe the company has the strength needed to gain market share in an industry battling commoditization. Despite its advantages and a 3% dividend yield, the company trades at 13x earnings.

Starting over? Weakness in Consumer Staples was driven by one of our retail holdings. The company announced a leadership change and will pursue a new business strategy. The new effort may also require additional spending. We were disappointed by the announcement and are reevaluating our commitment to the name.

Portfolio Activity

Given the economy remains unsettled, volatile stocks present greater downside risk in our opinion. We have sought to mitigate that factor by holding higher market cap stocks with superior franchises. The team has also looked for smaller companies that have a dominant industry position or those with realistic opportunities to improve results through self-help measures.

Recent addition Kennametal Inc. (KMT) is an example of a smaller name with an industry leading franchise that could significantly improve results through increased efficiencies. The company is the third largest maker of tools used in the metal working industry. Despite its dominant position in a consolidated space, it has suffered from a downturn in orders. Additionally, its decision to pursue a direct sales model that bypassed large dealers resulted in lower sales and reduced market share.

A new CEO with a plan to reduce costs and reorganize its sales efforts was appointed early in 2016. We are confident the approach should improve results. The stock is trading at 11x estimated 2017 earnings versus a historic average of 14x, which makes for a compelling risk/reward profile.

Outlook and Positioning

While the lingering economic uncertainty that has hung over the markets remains, the distortions it caused have tempered. As a result, we’ve been able to find compelling opportunities and have found a concentration of attractive investments among late stage cyclical names as well as larger companies.

While a move into late cyclical businesses is prudent in our opinion, we continue to monitor allocation risk and have structured the portfolio to benefit from stable companies with idiosyncratic factors. We continue to balance exposure to economically sensitive names with those that produce more consistent results regardless of the economy.

The byproduct of our bottom-up research is a portfolio with stronger balance sheets, which is more levered to global growth and is less sensitive to changes in dollar strength or a rise in inflation.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager David Fondrie

David Fondrie

Fondrie, CPA, is Senior Vice President and Portfolio Manager of the Select Value Fund and its corresponding separately managed account strategy. He has 22 years of industry experience, all at Heartland.

Heartland Advisors Value Investing Portfolio Manager Colin McWey

Colin McWey

McWey, CFA, is Vice President and Portfolio Manager of the Select Value and Mid Cap Value Funds and their corresponding separately managed account strategies. He has 15 years of industry experience, 8 at Heartland.

Heartland Advisors Value Investing Portfolio Manager Will Nasgovitz

Will Nasgovitz

Nasgovitz is CEO and Portfolio Manager of the Select Value and Mid Cap Value Funds and their corresponding separately managed account strategies. He also is CEO of Heartland Funds. He has 17 years of industry experience, 13 at Heartland.

Composite Returns*


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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Opportunistic Value Equity Composite (Net of Advisory Fees)**9.836.3112.605.5714.847.953.45
Opportunistic Value Equity Composite (Net of Bundled Fees)7.754.2610.423.5112.606.362.95
Russell 3000® Value6.715.8416.099.4616.3810.403.87

Source: FactSet Research Systems Inc., Russell Investment Group, and Heartland Advisors, Inc.

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†Composite return is net of advisory fees.
*Performance data is preliminary. Yearly and quarterly returns are not annualized. The Strategy's inception date is 9/30/1999.
**Provided as supplemental information.

Past performance does not guarantee future results.

In addition to stocks of large companies, the Opportunistic Value Equity Strategy invests in stocks of small- and mid-cap companies that are generally less liquid than large companies. The performance of these holdings generally will increase the volatility of the strategy’s returns.

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

Heartland Advisors, Inc. (the "Firm") claims compliance with the Global Investment Performance Standards (GIPS®). The Firm is a wholly owned subsidiary of Heartland Holdings, Inc., and is registered with the Securities and Exchange Commission. For a complete list and description of Heartland Advisors composites and/or a presentation that adheres to the GIPS® standards, contact the Institutional Sales Team at Heartland Advisors.

The U.S. dollar is the currency used to express performance.

As of 9/30/2016, Oshkosh Corporation, Kirby Corporation, Cisco Systems, Inc., and Kennametal Inc. represented 2.6%, 2.3%, and 2.5% of the Opportunistic Value Equity Composite, respectively.

Statements regarding securities are not recommendations to buy or sell.

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

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.

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®.

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

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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.