Stock selection was strong in a number of areas as the portfolio beat its passive Russell Midcap® Value benchmark. Materials stood out on a relative basis, along with the strategy’s Industrials and Information Technology holdings. The portfolio’s Consumer Staples names lagged, driven primarily by a single holding in the food products industry.
A Packaged Deal. The Materials sector was down in the broader index, but the portfolio’s names were up double digits and the group contained a top contributor.
Bemis Company, Inc. (BMS), the largest manufacturer of food packaging in North America, was up sharply after it agreed to be acquired by one of its global competitors.
Bemis is a long-time holding in the strategy, and last fall we increased our position meaningfully after shares weakened due to margin pressures and slowing sales as smaller players in the food packaging industry gained market share. In the most recent reporting period, the company made progress on improving its efficiency and increasing sales to middle market customers.
Shares reacted favorably to the progress and jumped further when the acquisition was announced. We reduced our position on the news but continue to maintain a stake as we wait for the gap to close between the offering price and the current trading range.
Balancing Act. The strategy’s Industrials names enjoyed widespread strength. We remain overweight the group but have taken a balanced approach in the space by holding a mix of economically sensitive names as well as those with steady streams of recurring cash flow.
Among the winners in the sector was Flowserve Corporation (FLS), a manufacturer and servicer of valves and pumps used in Energy production. The company is the only publically traded integrated business with the capability to manufacture seals. Because seals tend to fail at a relatively consistent pace, the capacity to make replacement parts provides Flowserve a competitive advantage among servicing peers and offers some consistency in cash flows.
Shares of the company were up after it reported results that significantly beat expectations for both top- and bottom-line growth. We were encouraged by the pace of organic growth of bookings including in its high-margin aftermarket business. Flowserve also showed progress operationally in its most challenged segment, the company’s Industrial Product Division, which manufactures standardized pumps.
We remain confident that management will be able to deliver on a plan to return margins to prior peak levels. Based on our expectations of improving sales and higher margins, we believe the company is trading at a significant discount to its Industrial peers.
Trash to Treasure? Although the majority of the portfolio’s Industrials holdings were up for the period, the group did contain a key detractor, Stericycle, Inc. (SRCL). The company provides waste management services for medical refuse and offers secured destruction of confidential and personal information. Shares were down after management issued lower-than-expected guidance for the year due to weakness in its non-core businesses.
We view the soft outlook as a temporary setback for a company that is trading at compelling valuations relative to long-term prospects. Stericycle faced a challenging pricing environment while renewing contracts in its medical waste business clients. Now that many of those contracts are in effect and are reflected in the bottom line, we expect to see sales once again grow on a period-over-period basis. Management also has ample opportunity to further improve efficiency and divest non-core units. These moves should increase margins in the quarters ahead.
Despite what we believe are achievable opportunities for improvement, Stericycle’s shares trade at just 13x earnings per share, well below the 20-40x its industrial waste peers.
Market gyrations spurred by macro events continue to create opportunities for patient investors. The lack of consensus on how long the business cycle will continue its robust growth has led to attractive valuations in both economically sensitive and defensive areas.
While the portfolio is less economically sensitive than in the recent past, we continue to follow our process where it leads us and have also added some high-quality cyclical names such as ManpowerGroup Inc. (MAN).
Manpower is a top-three global temporary staffing company with operations in 80 countries. The company has outsized scale in industrial temp staffing under the Manpower brand and professional temp staffing—for information technology, engineering, and finance—under the Experis brand. Manpower also has an outsized mix of revenue derived from Europe at 67% of total sales.
Manpower’s exposure to Europe, as shown below, has created an overhang for shares of the business as data has pointed to softening growth prospects in the region. Those concerns were amplified during the second quarter when the company reported slowing sales in Europe.
Keeping a Good MAN Down?
Source: Bloomberg L.P., Standard & Poor’s, and Heartland Advisors, Inc., 12/31/1998 to 6/29/2018, Quarterly
MAN Relative Performance vs. Equal Weight S&P 500 is represented by the ManpowerGroup Inc. stock price divided by the S&P 500 Equal Weight Index, both being set to a base value of 1 as of 12/31/1998 prior to the calculation (see last page for additional data). Eurozone Industrial Activity Ex Construction is represented by the Eurostat Industrial Production Eurozone Industry Excluding Construction (year-over-year, working day adjusted). All indices are unmanaged. It is not possible to invest directly in an index.
Past performance does not guarantee future results.
Although it is possible Manpower could experience additional erosion in its growth rate, we see current valuations as offering an attractive risk/reward, particularly relative to industrial stocks with more direct domestic exposure.
Longer term, we expect margins to expand as a result of management’s efforts to reduce costs through process automation and a heightened focus on exploiting cross-selling opportunities with existing customers, and we like management’s capital allocation strategy. Manpower’s balance sheet is strong, and the board has approved opportunistic share repurchases in the past. Higher margins with a lower share count should drive higher cycle-to-cycle earnings power.
With shares trading at 6x 2019 earnings before interest, taxes, depreciation and amortization, Manpower is priced at a more than 40% discount to its domestic peers and a 25% discount to its historical median.