Stock selection was strong in several areas, but the portfolio modestly lagged its Russell Midcap® Value benchmark for the quarter. Health Care stood out on a relative basis, along with the strategy’s Consumer Discretionary names. The portfolio’s holdings in Materials lagged.
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Positive results in Consumer Staples were driven by stock selection among food products businesses. Names like Sanderson Farms, Inc. (SAFM) continued to shine, and our conviction in the portfolio’s names remained strong. For example, during the period we added to long−time holding Bunge Limited (BG).
The decision to increase our investment in Bunge, a multi−line food and agribusiness company, was based on strides made by new management to quell earnings volatility and improve efficiency by better aligning resources with the needs of end clients. The moves are welcomed progress in what has been a volatile 24 months for the company.
In late 2017 and early 2018, there was widespread speculation that the company was a target for acquisition. Those rumors cooled after Bunge made an acquisition of its own, which was largely seen as a defensive bid by management to thwart a potential takeover.
In the months following the deal, Bunge, along with its competitors, struggled to generate strong margins due to a weak grain market globally. Despite the challenges, we believed the company had ample opportunity to streamline operations and drive better results. The steps management has taken suggests our thesis was well founded.
As the reconfigured board of directors and new CEO continue to make strides, we believe Bunge’s book value should grow and think the stock could have up to 20% in additional upside.
The portfolio’s Materials holdings were down, with names in the metals and mining space providing most of the weakness. The threat of a protracted trade war and signs of softening industrial activity took a toll on our raw−materials names including Cleveland−Cliffs Inc. (CLF), a Midwest−based iron ore producer.
We view weakness in Cleveland Cliffs’ shares as a short−term response to a near−term headwind. Instead, we remain focused on the transformative power of its new ore processing plant that makes hot briquetted iron, which is preferred by the U.S. steel manufacturers that are gaining market share. The project, which is slated to be completed in mid−2020, makes sense in our view, as it should provide a meaningful lift to cashflows.
We’ve also been impressed with management’s ability to raise dividends and buyback shares while investing in the construction of the new facility. As capital expenditures ebb with the completion of the plant, we expect Cleveland Cliffs to increase the capital it returns to shareholders.
With shares trading at just 5.5x enterprise value/earnings before interest, taxes, depreciation and amortization (EBITDA), we view the stock as having strong upside potential.
Supply concerns late in the period helped Energy stocks recoup some of their losses from earlier in the quarter, but the sector as a whole remained in the red. Demand concerns tied to a slowing economy persisted. The portfolio’s names were down but outperformed on a relative basis.
We’ve focused on reducing the impact of commodity prices on the performance of our names by finding businesses that offer differentiated products and services. Portfolio holding TechnipFMC PLC (FTI) is an example of our approach.
TechnipFMC provides equipment, engineering services, and project management to the oil and gas industry. The company’s integrated business model and technology gives it a leg up in the marketplace. We’ve been heartened by the significant inflection in orders during the past few quarters and gains in market share among subsea operators.
More recently, TechnipFMC announced plans to separate its engineering and construction business from its technology−focused subsea and surface units. The spinout, which is forecast to take effect in mid−2020, should unlock value as investors will have greater transparency into each unit as a standalone business.
We expect EBITDA, margins and earnings will continue to grow over the next several quarters as the recent rise in orders become completed projects.
Recent surges in volatility have created opportunities for investors willing to look beyond daily headlines or the latest earnings releases. During this period, we’ve sought to maintain a balanced approach rooted in valuations while also taking a clear view of the risk/reward profile of each business.
For example, the portfolio remains modestly underweight to the Consumer Discretionary sector, but we have found attractive valuation in consumer durables and are overweight the group. We recently added Mohawk Industries Inc. (MHK), one of the world’s largest manufacturers of commercial and residential flooring, after shares came under pressure.
Since late 2017, Mohawk has faced headwinds including increased costs, a slowing housing market, and margin pressures relating to ramped−up investments in expanding its luxury vinyl tile (LVT) production capacity. Over the next year, we expect the company to benefit from both improved LVT production efficiency and rising volume as Mohawk responds to improving retail and wholesale demand for flooring. Together, we expect these drivers to improve sales and margins.
Shares of Mohawk are trading at less than 12x estimated earnings compared with a long−term average of over 14x. As the company’s LVT production continues to ramp up, we expect investors will reward the company for improved margins and sales by bringing valuations more in line with its building−product peers, which are currently trading at about 16.5x earnings.
Beyond Consumer Discretionary, we continue to scour both economically sensitive and defensive areas for opportunities but are following our fundamental analysis to where it leads. While each investment decision is made on a stock−by−stock basis, the cumulative effect of our efforts is a portfolio that is less economically sensitive than in the recent past.
Mixed economic data, heightened volatility and uncertainty about the magnitude of the impact from ongoing trade disagreements highlight the need for a patient, disciplined investment approach. As such, we aren’t making market calls, but instead are focusing on capitalizing on the opportunities presented. We believe it’s important to avoid jumping into or out of positions based on the latest headline. Instead, the prudent course, in our view, begins with a clear−eyed assessment of the price paid relative to company−specific factors.
Thank you for the opportunity to manage your capital.