Heartland Value Fund 3Q19 Portfolio Manager Commentary

Executive Summary

  • Year-to-date, the Fund remains up double digits. 
  • This is only the third time in the past 35 years that the gap in valuations between large and small stocks has reached this level.
  • A contrarian streak, compelling valuations, and a laser focus on fundamentals are key to capitalizing on opportunities. 
Omne trium perfectum
—Latin phrase meaning “Everything that comes in threes is perfect”


Third Quarter Market Discussion

The rule of three is an age−old trick used by writers to make a piece more compelling. The idea is that a group of three provides perfect symmetry and makes for a more satisfying conclusion to a piece–think The Three Little Pigs, or Goldilocks and the Three Bears.

So, what does a writing concept have to do with investing? The chart below suggests plenty. As you can see, this is only the third time in the past 35 years that the gap in valuations between large and small stocks has reached this level of extreme. In the past, this disconnect has provided significant upside for those willing to stay the course with small stocks. Following the other two periods—during the recession of 1990 and again when dotcom mania was at its peak—small−cap investors in particular saw outsized returns in the months and years that followed.

Small−Cap to Large−Cap Historical P/E Ratio 
Source: ©2019 The Leuthold Group, 1/31/1983 to 8/31/2019
The Leuthold Group created this chart using their proprietary Leuthold 3000 Universe. This universe is defined as the largest 3,000 securities traded on U.S. exchanges and was segregated into large− and small−cap tiers. Gray bars identify recessionary periods of July 1990 to March 1991, March 2001 to November 2001, and December 2007 to June 2009.
Price/Earnings Ratio (P/E): non−normalized trailing operating earnings
Past performance does not guarantee future results.

Now, like then, we believe a contrarian streak, compelling valuations, and a laser focus on fundamentals are needed to capitalize on opportunities. Your portfolio, in our view, is filled with names that represent those three elements.

A Higher Power

For example, Vistra Energy Corp. (VST), with its unconventional mix of business, was up double digits as it continued to reap benefits from management’s decision to restructure and reduce debt load. This independent power producer provides retail electricity and wholesale power generation to the unregulated utility markets.

Vistra has demonstrated excellent visibility in producing free cash flow due to its combination of retail and wholesale business, along with its use of hedging to mitigate volatility in gas and electricity exposure. 

We’ve been impressed with leadership’s ability to pay down debt and its shareholder−friendly actions, including both initiating a dividend this year and buying back $1.3 billion—or approximately 9%—of shares outstanding. Trading at just 6.2X enterprise value/earnings before interest, taxes, depreciation, and amortization (EBITDA), and with an equity free cash flow yield of roughly 14%, Vistra’s shares, in our view, offer a compelling opportunity. We are further encouraged by significant recent insider buying.

Healthy Eating?

Holdings in the food products space handily outperformed the benchmark average and were helped by a unique niche player among the group. Landec Corporation (LNDC), which is comprised of a natural health foods business and a biomedical unit, was up sharply following a mid−summer shake−up in leadership. The board was restructured, and a food industry veteran was installed as CEO. The changes should result in a greater focus on free cash flow generation as the company seeks to cut costs in its low−margin, high−volume Curations Foods business and ramp up growth in its Lifecore biomedical division.

Curation foods generates over $500 million in sales—about 85% of Landec’s revenues—but costs have kept a lid on margins. Management is cutting underperforming lines/brands within the food group and has targeted $20 million in savings through increased use of automation in production.

Landec’s potential for expanding margins in its food line, along with Lifecore’s double−digit revenue growth and 30% EBITDA margins should, in our view, attract increased investor interest.

Golden Opportunity?

To spur economic activity and inflation, central banks around the globe continue to print money and expand their balance sheets through purchasing bonds, mortgages, exchange traded funds (ETFs), and other financial instruments. As a result, interest rates have plunged to record lows, with over $17 trillion of negative yielding sovereign bonds in the global financial system. 

Prudent investors have taken note and are increasingly attracted to hard assets to preserve their buying power. This renewed interest includes the historic storehouse of value, gold.
For some time, we have been attracted to the metal and hold a few miners that should benefit from these developments. Here’s one of our favorites.
Centerra Gold Inc. (CG CN/CAGDF) is a Toronto based company with mines on three continents: North America, Eastern Europe and Asia. We like this diversification and its rock−solid balance sheet with minimal debt exceeded by a growing cash hoard. Centerra is benefitting from higher gold prices that have led to a record year with more than $1 billion in sales, and, based on our research, record earnings.

Investors have noticed and have bid the stock up 100% this year.  We’ve trimmed a bit but continue to hold since the business is priced at only 5X current EBITDA and less than 4X our estimate for 2020. The company business is also selling at only 70% of our estimate of net asset value. 

Why we’re Optimistic

We can’t predict the future, of course, but recent market activity has us cautiously optimistic that a change in market leadership may be on the horizon.  After watching investors for years gravitate toward large, sexy growth names or pay up in a quest for low volatility, we saw a sharp trend reversal in mid−September. Small−cap stocks started to outpace large companies, formerly hot initial public offerings softened with some of the market darlings we skeptically pointed to last quarter (“Not Earning Their Keep?”) down 20% to 35% year-to-date. At long last, investors finally seem to be paying attention to valuations.

If, as we hope, the growth−at−any−price delirium of the past decade is finally breaking, we believe the valuations and strong balance sheets held in your portfolio and shown below will go a long way in helping investors capitalize on what we view as a third−in−a−lifetime opportunity. 
Value Fund Valuations

Heartland Advisors Value Investing Valuation Chart

Source: FactSet Research Systems Inc., Russell®, Standard & Poor’s, and Heartland Advisors, Inc., as of 9/30/2019
Price/Earnings and EV/EBITDA are calculated as weighted harmonic 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. 

With that, we’ll leave you with one more Latin phrase. A saying that fits with the approach we commit to daily at Heartland:
Carpe Pretium! 
(Seize the value)
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Portfolio Management Team

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.

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 20 years of industry experience, 16 at Heartland.

Fund Returns


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Since Inception (%)20-Year (%)15-Year (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD* (%)QTD* (%)
Investor Class
Institutional Class
Russell 2000® Value10.739.057.2310.067.176.54-8.2412.82-0.57
*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 5/1/2020, the Gross Fund Operating Expenses for the investor and institutional classes of the Value Fund are 1.10% and 0.92%, 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 9/30/2019, Centerra Gold Inc., Landec Corporation, and Vistra Energy Corp. represented 2.70%, 1.55%, and 3.60% 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.

Small-cap and large-cap investment strategies each have their own unique risks and potential for rewards and may not be suitable for all investors. Small-cap investment strategies emphasize the significant growth potential of small companies, however, small-cap securities, are generally more volatile and less liquid than those of larger companies. Large-cap investment strategies emphasize the stability of large companies, however, large-cap securities are more susceptible to momentum investments and may quickly become overpriced or suffer losses.

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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.

Dividends are not guaranteed and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.

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.