Heartland Value Fund 1Q19 Portfolio Manager Commentary

Executive Summary

  • The Fund had a rewarding start to the year and handily beat its passive benchmark, returning 13.53% versus 11.93% for the passive Russell 2000® Value index.
  • The impact of emotion is driving many to pay too much attention to the short term.
  • We believe this unwavering valuation-first approach offers meaningful opportunity for capital appreciation.
“You've tried to stop my brilliant ideas with common sense a thousand times."
—Yogi Bear, fictional animated character

First Quarter Market Discussion

A V-shaped snap back helped equities recover from the fourth-quarter selloff of 2018. Your portfolio had a rewarding start to the year and handily beat its passive benchmark.
While the strong performance is welcomed, we are frustrated by the persistence of what we see as a bear market in logic. Volatility of the past six months has been long on what Yogi Bear might describe as “brilliant” emotion and short on common sense. How else would you describe the movements in shares of Berry Petroleum Corporation (BRY)! 
Uncertainty about near-term oil prices sent Energy companies tumbling last quarter, Berry included. Shares of the oil & gas producer dropped from a high of $18 to just over $8. For a seasoned producer with a solid balance sheet, a swing like that looked to us like panic, not price discovery. After checking in with BRY’s management team and refreshing our research, we took advantage of indiscriminate selling and added to Berry late last year based on its attractive valuation: it closed the year priced at 80% of book value, less than 6X earnings, plus offered a 5% dividend yield.
This conviction paid off as shares were up as much as 45% during the period, yet Berry still trades well below our estimate of intrinsic value. Below are updates on a few more names we highlighted following the selloff last quarter.
Accuray Incorporated (ARAY)—Global producer of radiation oncology equipment
  • Announced a joint venture with one of the largest medical companies in China to manufacture and sell systems in China
  • Successful phase 3 safety trial of prostate cancer treatment
  • Reported a record backlog of $482 million versus a market cap of $408 million and shares rose nearly 40% for the quarter
  • Continues to look attractive to us with shares trading at 1X sales versus peers trading at 3X-4X
Northwest Pipe Company (NWPX)—Leading manufacturer of water transmission systems in North America
  • Reported a record backlog of $252 million—up 186% versus prior year
  • Year-over-year earnings improvement
  • Shares of NWPX rose 3%, following up an 18% gain for the fourth quarter, but are still priced just above book value
Century Communities, Inc. (CCS)—Top-ten national homebuilder 
  • Reported better than expected earnings for the quarter and year
  • Grew sales by 50% for 201
  • Shares of CCS rose 38.8% but still look attractive at just 7X estimated earnings

Risky devotion to emotion?

While we are pleased to see the above companies getting some attention, we’re struck that one of the main drivers of performance has simply been a change in the mood of investors. 
The impact of emotion is driving many to pay too much attention to the short term and thus overlook businesses with solid fundamentals and valuations. Instead of chasing an investment horizon of just a few weeks or months, we take the long view and stick to our time-tested 10 Principles of Value Investing™.
First Solar, Inc. (FSLR) is a recent addition and an example of what our active, fundamental approach has unearthed. The company is a U.S.-based, pure¬-play manufacturer of solar power systems and modules. Due to what we believe to be a short-term disappointment in results, the business was marked down in price by 40%.
The solar energy industry, in our view, is poised for strong growth in the coming years due to an aggressive push for renewable energy as well demand dynamics that now favor producers. Against this backdrop of improved pricing power, we believe First Solar is well-positioned to grow earnings by as much as 80% year-over-year for 2019.  
First Solar also boasts a rock-solid balance sheet with nearly $20 per share of net cash on the books. Yet despite secular tailwinds for demand—including state mandated renewable energy requirements for utilities—the stock trades at just 1.1X book value. 
We see a long growth runway for the company.

Opportunities Remain

The fact that we continue to find exceptional valuations in the midst of a decade-long bull run is a remarkable reminder of the value of an active bottom-up approach to investing. We remain unwavering in our focus finding these compelling opportunities and believe recent outperformance highlights the potential for the names in the portfolio. 
Our work in finding deeply out of favor companies priced well below market multiples is reflected in a portfolio that is trading at a forward price/earnings multiple of less than 12X versus an average for the broader market of 17X. We believe this unwavering valuation-first approach offers meaningful opportunity for capital appreciation over the long-term.
Value Fund Valuations 
Heartland Advisors Value Investing Valuation Chart
Source: FactSet Research Systems Inc., Russell®, Standard & Poor’s, and Heartland Advisors, Inc., as of 3/31/2019
Price/Earnings and EV/EBITDA are calculated as weighted harmonic average and Dividend Yield as weighted average.
Enterprise Value/Earnings Before Interest, Taxes, Depreciation, and Amortization (EV/EBITDA).
Certain security valuations and forward estimates are based on Heartland Advisors’ calculations. Certain outliers may be excluded. Any forecasts may not prove to be true. Economic predictions are based on estimates and are subject to change.
All indices are unmanaged. It is not possible to invest directly in an index.
Past performance does not guarantee future returns.
Thank you for your continued confidence.
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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Bill Nasgovitz

Bill Nasgovitz

Nasgovitz is Chairman and Portfolio Manager of the Value Fund and its corresponding separately managed account strategy. He has 51 years of industry experience, 37 at Heartland.

Heartland Advisors Value Investing Research Analyst Eric Miller

Eric Miller

Miller is a Research Analyst. He has 26 years of industry experience, 16 at Heartland.

Heartland Advisors Value Investing Portfolio Manager Will Nasgovitz

Will Nasgovitz

Nasgovitz is CEO and Portfolio Manager of the Select Value, Mid Cap Value, and Value Funds and their corresponding separately managed account strategies. He also is President and Director of Heartland Funds. He has 19 years of industry experience, 16 at Heartland.

Fund Returns

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*Not annualized

The inception date for the Value Fund is 12/28/1984 for the investor class and 5/1/2008 for the institutional class.

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In the prospectus (pdf) dated 5/1/2019, the Gross Fund Operating Expenses for the investor and institutional classes of the Value Fund are 1.07% and 0.90%, respectively. The Advisor has voluntarily agreed to waive fees and/or reimburse expenses with respect to the institutional class, to the extent necessary to maintain the institutional class’ “Net Annual Operating Expenses” at a ratio not to exceed 0.99% of average daily net assets. This voluntary waiver/ reimbursement may be discontinued at any time. Without such waivers and/or reimbursements, total returns may have been lower.

Past performance does not guarantee future results. Performance represents past performance; current returns may be lower or higher. Performance information for institutional class shares of Funds that existed prior to their initial public offering is based on the performance of investor class shares. The investment return and principal value will fluctuate so that an investor's shares, when redeemed may be worth more or less than the original cost. All returns reflect reinvested dividends and capital gains distributions, but do not reflect the deduction of taxes that an investor would pay on distributions or redemptions. Subject to certain exceptions, shares of a Fund redeemed or exchanged within 10 days of purchase are subject to a 2% redemption fee. Performance does not reflect this fee, which if deducted would reduce an individual's return.

An investor should consider the Funds’ investment objectives, risks, and charges and expenses carefully before investing or sending money. This and other important information may be found in the prospectus (pdf). To obtain a print prospectus, call 800-432-7856. Please read the prospectus carefully before investing.

As of 3/31/2019, Accuray Incorporated, Century Communities Inc., Berry Petroleum Corporation, First Solar, Inc., and Northwest Pipe Company represented 2.06%, 1.31%, 1.67%, 0.76%, and 1.45% of the Value Fund’s net assets, respectively.

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 are sourced from GICS®.The Global Industry Classification Standard (GICS®) is the exclusive intellectual property of MSCI Inc. (MSCI) and S&P Global Market Intelligence (“S&P”).  Neither MSCI, S&P, their affiliates, nor any of their third party providers (“GICS Parties”) makes any representations or warranties, express or implied, with respect to GICS or the results to be obtained by the use thereof, and expressly disclaim all warranties, including warranties of accuracy, completeness, merchantability and fitness for a particular purpose.  The GICS Parties shall not have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of such damages.

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®.

Because of ongoing market volatility, performance may be subject to substantial short-term changes.

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

The above individuals are registered representatives of ALPS Distributors, Inc.

The Heartland Funds are distributed by ALPS Distributors, Inc.

The Value Fund primarily invests in small companies selected on a value basis. Such securities generally are more volatile and less liquid than those of larger companies.

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