4Q25 Mid Cap Commentary Podcast

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Transcript

Michael Kops: Hello, this is Michael Kops, Heartland Advisors. I'm joined by my teammates on the Mid Cap Value Strategy, Colin McWey and Troy McGlone.

Guys, what would you say about the fourth quarter for Mid Cap Value?

Colin: Well, it was a continuation of some of the themes that people had been, that had been driving stocks for much of the year. And in some cases, it really accelerated into Q4. So, namely, the artificial intelligence narrative continued to dominate the marketplace.

There were signs at various points throughout the quarter of the market broadening out. And, you know, companies that are valued more reasonably under a range of outcomes started to take some leadership. But that proved to be short-lived for the time being. At the end of the day, the best way we could characterize the backdrop is that the valuation disparities are as wide as we can ever recall. Especially if you value companies under a wide range of outcomes which we do. And what's interesting is when you can make those observations across the marketplace and you know some of the reasons that that that is the case today you can see some of the different views of company valuations reflected in insider activity. So across the marketplace with the market at all-time highs you can see insider buying in a host of companies including many in our portfolio that we feel are more attractively priced under a wide range of outcomes. And conversely, frankly, in some of our holdings that we view as more fairly valued and widespread across the mid-value universe, you can see rampant insider selling.

Mike: So would you say the behavior in the fourth quarter. How would you describe it in terms of, you know, making you more anxious about the setup for the portfolio or more optimistic?

Colin: We think that the valuation disparities with good fundamental work and the right time horizon is very exploitable. Not exploitable in the sense of predicting what will happen over the next quarter. But when we can see in price companies according to four different scenarios, including very good scenarios, base case scenarios, and extreme downside scenarios. With the right time horizon, the right approach, the right focus on downside risk. We feel that this is something that can be exploited and prove out over time.

So it actually leaves us quite optimistic, not for the absolute direction of the market, not saying that there aren't extremes out there. There absolutely are. But for a sound value approach, we feel that this should be something that can be capitalized on.

Troy: Yeah, if you look at the composition of our performance in the fourth quarter, our Quality Value holdings were actually negative, the total return. And so for us, that just means that there's a greater margin of safety. So as it relates to how we feel about the portfolio, we're getting high quality businesses that are cheaper than they were three and six months ago because of the market drop, backdrop, is providing that opportunity for us.

Colin: One of the things that Troy, myself, and the broader team rest on at this time is what can we focus on?

Well, one of the things we can absolutely focus on is the general investment thesis and the investment premise playing out. If it is, get less concerned about whether or not the stock prices are keeping up in a euphoric backdrop when we know what's driving the backdrop to a certain extent. is the investment thesis playing out.

For all of our material holdings, which we would define as over one and a quarter percent, the investment thesis, the investment premise is on solid ground. Now, in some cases, like at J.B. Hunt, that has more recently been rewarded with improved relative stock price performance. In some cases, like MarketAccess, we feel that the company has set the table through a soft patch for their business to get rewarded over time. We feel that the table has been set.

In some cases, we get thrown a curveball from our holdings and more specifically the management team. And candidly, in the case of Kimberly Clark, we were thrown a capital, a major capital allocation curveball in Q4. And in those cases, you need to be intellectually honest, measure that fact pattern versus your other alternatives.

Mike: Excellent. So, I think you'd give them some pretty good color on what drove performance. I know there was a lag for the quarter. Anything else you'd want to comment specifically about the relative performance for the quarter? 

Troy: I would just say within the value, Quality Value bucket, which is higher quality portion, drove our entire underperformance. It was driven by stock selection. So, to Colin's point on what, where the market is allocating capital right now, it is not towards the Quality Value space.

We have a chart in our commentary from Leuthold that shows the steep amount of underperformance of high quality. So, really it’s consistent with what we're seeing in our own portfolio and really at a whole Quality Value in the portfolio did actually, or in the benchmark actually outperformed slightly, which is the first time in about seven quarters. So frankly, for us, it is early sign of an inflection in the relative performance of that category, but it's not a full stop inflection. The performance and the benchmark across the two buckets was relatively consistent with a lot of volatility within the quarter.

Mike: Got it. How about another example in the portfolio? Just kind of bring us in a little bit.

Troy: Yeah, I think one of the better performers in the quarter, certainly not over the last few years for us, is a company in our Industrial sector, which is J.B. Hunt. It's a transportation company. Industrial stock selection has been poor over the last couple of years, and it's not because we've had stocks that have gone down a lot necessarily. It's more of a function of not owning a lot of businesses that are tied to companies. You know the the theme of the day which is tied to let's say AI infrastructure build-outs for example. J.B. Hunt is more of a reflection of the broader economy, their biggest business is intermodal shipping so their containers move freight across the across the country and it's been an underperformer because there's been an oversupply of capacity in the truckload market. Which think of the 18 wheelers driving down the freeway. That has, it's a substitute product for J.B. Hunt's more efficient product, but ultimately when the market's oversupplied, if you're a shipper, if you're Walmart, you can choose to say, well, I'm just going to go with a truckload carrier because I can get the best price today and I know that my freight will show up in time. And so that's been a headwind for the last few years for J.B. Hunt, but they're starting to execute on their self-help. It's a Deep Value business. And what we've seen in the third quarter, they reported strong results. They provided margin expansion in their intermodal segment even though the number of loads that they shipped were down. And that's because they're getting better at managing their capacity internally and becoming more and more efficient. And so in that backdrop the stock was rewarded and it's the first positive inflection that we've seen where the market's willing to pay attention to something where you know they've been going through a recession in their business effectively their earnings have declined materially from the prior peak. So we think we're buying it at a discount with earnings depressed and ultimately they're doing the right thing with capital. Free cash flow is strong. They're buying back shares. They bought back a little under 5% of the stock over the last year, and the balance sheet remains in a great position. So for us, it's a material holding, and we're pleased to see a positive inflection. 

Mike: Excellent. How about the outlook for the year? I know we've talked about the backdrop and what we went through in 2025. How about looking out here for the rest of 2026?

Colin: Well, one of the things we said earlier is that we feel that the valuation disparities are exploitable, but we will not promise the time flame, time frame when that plays out. What we would say is it's been encouraging so far this year, and it's very early, to see signs, early signs of that broadening out happen again. And that's reflected in some stocks that have been dearly valued, coming under a little bit of pressure against very elevated valuations, as well as some of the more orphaned names last year, start to catch a little bit of a bid, behave better against what, again, we consider a much more reasonable valuation under a wide range of scenarios.

So, we are cautiously optimistic, but we know we can't predict the timing that at some point, some of the underlying fundamental valuation and quality traits across different businesses in mid-cap value will actually get recognized. And look, we say these things with a very healthy respect for the potential fundamental impact of AI on the economy, on corporate fundamentals. We believe that there are, that a value investor can roll their sleeves up and with the right time horizon, really assess the long-term opportunities and the long-term risks from artificial intelligence.

Namely some of the folks who have the right industry structure and capabilities to capitalize on long-term durable benefits. So, we believe that in value land, it's not about saying that the market's wrong in terms of the prospects of AI as a whole, but that's very different than talking about what's priced into securities today. And that is the opportunity that we think is exploitable across the marketplace, along with all of the other considerations regarding valuation and fundamentals to capitalize on. So we're hopeful that as we go through 26, there's more of that.

Mike: Excellent. Any final thoughts?

Troy: No, I think Colin said it well. I think there are opportunities for us in both of our Quality Value and Deep Value buckets. In the Deep Value bucket, we've suffered from the fact that we are focused on identifying companies that have a self-help catalyst to unlock value. That really hasn't been a requirement. In fact, it's been a deterrent. There's been more of a rising tide effect in that bucket of securities that we don't believe is sustainable. And ultimately, our long-term opportunity is to continue to focus on bottoms-up research. 

In the Quality Value space you know we've identified a number of companies that can perform quite well regardless of the direction of the economy frankly it's a unique opportunity to find businesses that have a heavy exposure to say an annuity like revenue stream, a lot of repair and replace for example maintenance and repair, and so regardless of the direction of the economy given the uncertainty that's out there frankly you know what we think we're very well positioned because those businesses will continue to, you know, take market share and growth throughout any sort of economic cycle. And they're trading at, you know, multi-decade opportunities, in our opinion.

Mike: Excellent. Thank you, guys.