Heartland Advisors

1Q24 Mid Cap Commentary Podcast


Mike Kops: Hello, I’m Michael Kops, Vice President at Heartland Advisors located in Milwaukee, WI. Thank you for listening to the podcast, our first!

For four decades, Heartland has focused on what we do best; uncovering U.S. businesses trading at compelling valuations and offering the potential for capital appreciation through our 10 Principles of Value Investing™. 

Today I’m joined by Colin McWey, portfolio manager for the Heartland Mid Cap Value Strategy, who will be discussing recent performance and providing related market insights.

Colin, thanks for joining me. In the first quarter, the markets seemed to find another gear. What are your thoughts?

Colin McWey: That’s right. The narrative went from talk of a ‘hard landing’ (or a deep recession) if you go back to pockets of 2022 and 2023 to the idea of a ‘soft landing’ (which is a mild recession) and interestingly the narrative even developed lately where people are talking about ‘no landing’ which means (no recession) at all and the economy just reaccelerates without a real downturn. 

Investors, who worried about a potential slowdown in 2022 and early 2023, shifted their focus toward potential upside in 2024.

Mike: What were some of those ‘upsides’ that investors were focusing on?

Colin: For starters, there’s monetary policy. Investors entered the year hoping the economy could get a boost from a lower Federal Funds rates. That hope remains, though it’s unclear when those rate cuts might begin. 

And then there’s the massive fiscal stimulus out there from federal infrastructure spending. 

And, of course, there’s the euphoria has built surrounding AI and the potential productivity increases it could bring to the economy.

Mike: Heartland Mid Cap Value posted a gain of 5.7% in the first quarter. That trailed the Russell Midcap Value Index, which was up 8.2% in the quarter. What do you attribute that underperformance to?

Colin: Well, frankly speaking, Part of it was a low hit rate on our stock selection in Financials and Industrials, due to both the securities we hold as well as the ‘opportunity cost’ of not owning certain other stocks.

For example, in the first quarter, cryptocurrency-related stocks like Coinbase and Robinhood saw their shares surge as the price of digital tokens jumped. Amazingly, Coinbase and Robinhood are both in the Russell Midcap® Value Index. In fact, Coinbase, Robinhood, Block, and SoFi Technologies make up more than 6% of the Financial sector of the midcap value benchmark.

Because we are committed to attractively priced, well-run companies with strong fundamentals guided by our 10 Principles of Value Investing™, we think it’s often imprudent to own such businesses. So, are actually quite comfortable not allocating there.

Mike: What type of companies are you comfortable owning?

Colin: We believe our efforts are better spent identifying undervalued shares of financially strong businesses, even if it takes time for the markets to see their true value. 

As an example, First American Financial Corporation in the Financial sector and J.B. Hunt Transportation Services, Inc. in Industrials. Both are in our portfolio, and were detractors to our relative performance in the first quarter. Yet they are industry-leading cyclical businesses working their way through kind of the weak point in their business cycles. Our thesis for owning both of these companies remains unchanged.

Mike: Great, can you describe your overall approach to constructing Mid Cap Value’s portfolio?

Colin: Yeah, the over-arching goal is to allow bottom-up stock-picking to be the primary driver of performance in a focused portfolio.  With that in mind, we construct the portfolio with two distinct buckets of companies and use one stock-picking process.  One bucket (that we call “quality value”) includes a mix of high-quality companies trading at decent bargains.  The 2nd bucket is our “deep value” bucket and includes deeply discounted companies that have produced poor economic returns over time but have a catalyst for more better future returns on capital looking forward.  

We do this because these two styles within value investing have historically alternated market leadership, so if you think about it just as growth and value strategies generally take turns outperforming each other, the same thing happens within these two buckets of companies.  The swings in performance between deep value vs. quality value can actually be as pronounced as swings between growth and value stocks.  We consider this one of the most unspoken allocation bets that happens in active management. So, to mitigate the risk of underperforming due to unintended allocation bets — and to maintain the focus on security selection — we embrace this two-bucket approach. It helps ensure that we fit our piece of the asset allocation puzzle in various environments.

And interestingly, in both buckets, the stock-picking process begins with our 10 Principles of Value Investing™ and it guides our investment decisions.  The process is a well-defined value discipline that allows for what we think is the right mix of both style-purity, but enough flexibility to be effective across different industries and business models. 

Mike: How does this two-bucket approach work in today’s market?

Colin: Today’s economy offers a good illustration of how useful a balanced approach can be.

For example, we are not entirely convinced of the ‘no landing’ narrative that is dominating the markets. Emerging from the global pandemic, households have drained down their excess savings, with personal savings as a percentage of disposable income down to historic lows. Consumers aren’t just saving less, they are borrowing more — so auto loans, 401(k) loans, and credit card balances are all on the rise, as are delinquencies on repaying that debt. 

While we are skeptical of a ‘no landing’ scenario, we also can’t say for certain that conventional wisdom is wrong. If the market continues in ‘risk on’ mode, deep value securities could have an outsized benefit. But if the economy is weaker than expected, capital is likely to favor quality value characteristics including high returns on capital, robust free cash flow, and pricing power. 

Mike: Can you give us some examples of stocks that fall into these buckets?

Colin: Sure, let’s talk about Donaldson, this is a relatively new position we initiated in the first quarter. Donaldson is a filtration manufacturer with over a century of experience in air, lubricant, hydraulic, and fuel applications. 

The stock typically trades at a premium to its peers, that’s a reflection of its high profit margins and economically resilient revenues. However, the company has faced margin headwinds lately, partly due to very heavy upfront investment in its fast-growing life sciences segment. We think investors have already incorporated the life sciences operating losses in Donaldson’s valuation. We also believe the segment will ultimately be accretive to both revenue growth and margins. 

We’re mindful that investors don’t typically embrace industrials when the ISM Manufacturing Purchasing Managers Index is declining, as has been the case from late 2021 through late 2023. Donaldson, however, has historically outperformed when industrial activity weakens. So we think thatmakes Donaldson a good example of a stock that could perform well on a relative basis if the economy slips into a recession while also providing significant upside potential if the economy continues to grow. 

Another new quality value position in the portfolio is The Hershey Company, which makes popular chocolates and candies under the Hershey’s, Reese’s, Cadbury, and Jolly Rancher brands, so really household brands.

Hershey has historically traded at a premium to other consumer staples stocks. But in an environment where consumer finances are stressed and input costs are climbing, that premium has really disappeared. The stock is down 35% from its 2023 peak due to volume headwinds and margin pressures brought about by rising cocoa prices.

We believe Hershey simply needs to demonstrate to investors that these headwinds are cyclical and temporary in nature, while once again showcasing its ability to balance superior profitability with modest growth and stable market share. 

While we cannot predict when cocoa prices deflate, we are confident Hershey and its largest competitors will be slow to reverse price increases required to recoup the input cost squeeze. Meanwhile, the stock trades near historic lows relative to other blue chip consumer staples stocks, and actually it trades at historic lows versus the staples sector as a whole, and the broad market.

Mike: Can you give us an example of a stock in the deep value bucket?

Colin: Perrigo is a holding that has slumped lately, but we’re encouraged by its self-help progress. 

This is a consumer health company, with private-label brands in areas ranging from digestive health medications to allergy and pain relief. About 12% of sales are also tied to infant formula sales. Last September, the FDA updated guidelines for the agency’s approach to inspecting infant formula production. This included more frequent cleaning of manufacturing facilities, and it actually resulted in a significant slowing down of production. 

Perrigo shares fell in response to news that the cost to remediate its infant formula plants will be higher than expected. However, the stock recovered a little bit more recently, after the CEO appeared at an industry conference and reported faster-than-expected progress made on infant formula remediation. 

This ongoing progress on the infant formula issue should help refocus investors on positive developments underway elsewhere in the company, including Perrigo’s self-help strategy. In the U.S., that involves making its operation look more like its business in the United Kingdom, where higher-priced, brand-name versions of the same private-label treatments are manufactured and sold at 2 to 2.5 times the gross margin of store-branded drugs. 

Perrigo’s stock is seemed considerable insider buying of late and is attractively priced at just 12 times earnings.

Mike: So, what’s your final take-away for the quarter?

Colin: In the long run, our stock-picking success hinges on avoiding short-term speculation and staying true to our 10 Principles of Value Investing™, which demands that we stick with well-run companies with strong balance sheets trading at attractive valuations. 

We don’t know how the economy unfolds this year — no one really does. That’s why we remain focused on those things we can control. That includes: 

  1. Investing in quality value businesses that we think are trading at an appropriate discount to their intrinsic value while avoiding those that lack valuation support.
  2. Holding an equal-to-overweight position in the quality value category while maintaining adequate representation in the deep value bucket. And that again is meant to avoid non intended allocation bet. 
  3. And ultimately, purchasing deep value businesses only after identifying a self-help catalyst that we think can unlock value with execution. This strategy has served us well over periods measured in years, not quarters.

Mike: That sums it up well. Thanks for your time, Colin. 

And thank you for listening.

Please wait while we gather your results.


Heartland Advisors Value Investing Portfolio Manager Colin McWey

Colin McWey

Vice President and Portfolio Manager

Heartland Advisors Value Investing Relationship Manager Michael Kops

Michael Kops

Vice President and Partner


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Past performance does not guarantee future results.

The Mid Cap Value Strategy seeks long-term capital appreciation by investing in mid-size companies as defined by the market capitalization range of the Russell Midcap® Index. This focused portfolio seeks companies with strong underlying business franchises priced at a discount to their intrinsic worth that have temporarily fallen out of favor.

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As of 3/31/2024, Donaldson Company, Inc. (DCI), First American Financial Corporation (FAF), The Hershey Company (HSY), J B Hunt Transport Services Inc. (JBHT), and Perrigo Co. PLC (PRGO), represented 2.55%, 3.02%, 2.45%, 3.35%, and 2.74% of the Mid Cap Value Composite’s net assets, respectively. Block, Inc. (SQ), Coinbase Global, Inc. (COIN), Robinhood Markets, Inc. (HOOD), and SoFi Technologies Inc. (SOFI), are unowned by Heartland Advisors, Inc.

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