Heartland Value Plus Fund 2Q21 Portfolio Manager Commentary

Executive Summary

  • The portfolio added to its double-digit gains from the prior quarter but ended the period lagging its benchmark. 
  • The snap back from the pandemic has been impressive, but it loses some of its luster when looking at the amount of debt it generated. 
  • The flood of fiscal stimulus unleashed to restart the economy has created distortions in the supply/ demand balance in many industries.  
  • the willingness to extrapolate the current goldilocks backdrop of low interest rates, easy sales comparisons, and low inflation into the foreseeable future is misguided, in our view.    

Past performance is no guarantee of future results and investment returns and principal value of the Fund will fluctuate so that shares, when redeemed, may be worth more or less than the original cost. Current performance may be higher or lower than the performance quoted. Call 800-432-7856 or visit heartlandadvisors.com for current month end performance.

Second Quarter Market Discussion

It was full steam ahead for the rampant economic optimism that has reigned over the markets since the year began. Plummeting COVID-19 cases, high demand for workers, and a steady stream of proposals out of Washington D.C. to pump ever-more trillions of dollars into the economy left investors with a sense of invincibility. 
The euphoria continued this year’s surge for equities, and the major indices hit record highs during the closing days of the period. With investors seemingly fixated on only positive headlines, little attention was paid to fundamentals of individual companies. The indifference toward risk led to a surge for so-called meme stocks, such as AMC Entertainment Holdings Inc. (AMC), a money-losing business with a shaky balance sheet whose shares were up 2,500% through the first half of the year.
As fundamental investors, we are always wary of markets driven by momentum and macro events, and the current situation is no different. While the snap back from the pandemic has been impressive, it loses some of its luster when looking at the amount of debt it generated.

The correlation between ballooning balance sheets at the Federal Reserve and the fortunes of the equities market, as shown below, is striking. The willingness of the Fed to open up its balance sheet to save debt-laden businesses is unsustainable in our view and underscores the importance of active managers who make clear-eyed risk assessments of prospects for individual companies.
A Fed-Funded Party  

Heartland Advisors Value Investing FARBAST to S&P 500 Index

Source: Bloomberg L.P., Standard & Poor’s, Daily data from 7/1/2020 to 6/29/2021. The FARBAST Index outputs the US Federal Reserve’s balance sheet in millions of USD, updated weekly. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

Attribution Analysis

The portfolio added to its double-digit gains from the prior quarter but ended the period lagging its benchmark, the Russell 2000® Value Index. Stock selection in Financials was strong as were holdings in the Health Care sector. The portfolio’s holdings in Industrials were down and lagged the benchmark average for the group.  
Heartland Advisors Value Investing Health Care Sector IconEnergized. Oil prices remained firm during the period, and Energy stocks benefited. Stock selection in the group boosted absolute portfolio returns. Holdings in the Equipment and Services space were particularly strong, including Dril-Quip Inc. (DRQ), which specializes in serving the offshore/subsea markets.
Dril-Quip’s sales were slightly weaker than forecasted for the most recent period, but the company reported strong margin growth as efforts undertaken to boost bottom-line results began to pay off. Additionally, bookings for future projects were up, and we expect expenses will continue to improve as management’s plan for reducing inventory levels continues to progress.   

Despite the promising outlook, Dril-Quip trades at less than 8x estimated 2022 earnings before interest, taxes, depreciation, and amortization. 
Heartland Advisors Value Investing Information Technology Sector IconNo pain no gain. The portfolio’s Health Care names were up on a relative and absolute basis but also contained a key detractor, Avanos Medical Inc. (AVNS).
Avanos, a medical device company that focuses on the pain management and chronic care markets, saw its shares weaken after its gross profit margins shrank due to a combination of short-term supply chain issues and a sales mix for the most recent period that was light on some of its high-margin products.

We remain constructive on Avanos and believe the issues with its supply chain are temporary and that management has a sound plan for driving margins back up to the 60% level the business previously enjoyed. Additionally, the improved outlook for elective procedures should drive a resumption of demand for Avanos products.
While the outlook remains positive for the company, shares trade at 2.5x estimates of 2022 enterprise value/sales—well below the 4x multiple commanded by its medical device peers.
Heartland Advisors Value Investing Information Technology Sector IconCash is king. Financials in the broad market were flat despite better than expected loan performance. The portfolio’s holdings in the sector outperformed on a relative basis, and the group included FirstCash Inc. (FCFS), a top contributor for the period. 
Shares of FirstCash, which operates pawn stores in the U.S. and Latin America, jumped as the impact of COVID-19 stimulus checks began to fade and pawn loan demand started to improve. We remain constructive on the business due to its high margins and view it as uniquely positioned to thrive should the financial resiliency of consumers soften. 

Despite the favorable move for shares of the company, the stock trades at just 1.5x tangible book value vs. a long-term average of 2.5x.

Portfolio Activity 

The flood of fiscal stimulus unleashed to restart the economy has created distortions in the supply/demand balance in many industries. As the last of the stimulus checks are spent and enhanced unemployment payments wind down, we believe some of those anomalies will be righted. The sustainability of consumer spending and the outlook for companies in the Consumer Discretionary sector is an area that could be ripe for revised expectations. 

An analysis of recent trends shows that the growth in retail sales over the past year has coincided with the amount of stimulus being doled out to consumers, as opposed to base wages. While consumer spending might remain elevated in the short term, we believe spending will begin to fade as government payments wind down. In response, we remain underweight the group as we seek businesses where our clients will in our view be adequately rewarded for the heightened risk that could come as stimulus funds wane.

Outlook and Positioning

There was plenty for investors to cheer during the first half of the year, yet sensible bullishness toward an economy that was regaining its previous form has morphed into excessive optimism and an intense focus on immediate rewards without consideration of longer-term challenges. 

The willingness to extrapolate the current goldilocks backdrop of low interest rates, easy sales comparisons and low inflation into the foreseeable future seems misguided—and fraught with risks. 

As such, we believe as active managers it is important to maintain a focus on appropriately managing risks in the portfolio. That means seeking out businesses that are well positioned to drive free cash flow growth and those with the financial strength and pricing power necessary to weather the long-term uncertainty of a world awash in debt. We believe this approach will produce a portfolio of companies that should have enduring strength for the long haul.

Thank you for the opportunity to manage your capital.

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Portfolio Management Team

Bradford A. Evans

Senior Vice President and Portfolio Manager

Andrew J. Fleming

Vice President and Portfolio Manager

Fund Returns

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*Not annualized

Source: FactSet Research Systems Inc., Russell®, and Heartland Advisors, Inc.

The inception date for the Value Plus Fund is 10/26/1993 for the investor class and 5/1/2008 for the institutional class.

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©2022 Heartland Advisors | 790 N. Water Street, Suite 1200, Milwaukee, WI 53202 | Business Office: 414-347-7777 | Financial Professionals: 888-505-5180 | Individual Investors: 800-432-7856

In the prospectus dated 5/1/2022, the Gross Fund Operating Expenses for the investor and institutional class of the Value Plus Fund are 1.15% 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 for institutional class shares prior to their initial 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. To obtain performance through the most recent month end, call 800-432-7856 or visit heartlandadvisors.com.

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 Funds' prospectus. To obtain a prospectus, please call 800-432-7856 or visit heartlandadvisors.com. Please read the prospectus carefully before investing.

As of 6/30/2021 Avanos Medical Inc. (AVNS), Dril-Quip, Inc. (DRQ), and FirstCash Inc. (FCFS) represented 1.63%, 1.87%, and 2.91% of the Value Plus Fund’s net assets, respectively. AMC Entertainment Holdings Inc. (AMC) was unowned. 

Statements regarding securities are not recommendations to buy or sell.

Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk.

The Value Plus Fund invests in small companies that are generally less liquid and more volatile than large companies. The Fund also invests in a smaller number of stocks (generally 40 to 70) than the average mutual fund. The performance of these holdings generally will increase the volatility of the Fund’s returns. There is no assurance that dividened paying stocks will mitigate volatility. 

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

The Value Plus Fund seeks long-term capital appreciation and modest current income.

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

The Heartland Funds are distributed by ALPS Distributors, Inc.

The statements and opinions expressed in this article are those of the presenter(s). 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.

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.

There is no assurance that dividend-paying stocks will mitigate volatility.

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Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indices. Russell® is a trademark of the Frank Russell Investment Group.

Data sourced from FactSet: Copyright 2022 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

Absolute Value is a business valuation method that uses discounted cash flow analysis to determine a company's financial worth. Absolute value models try to determine a company's intrinsic worth based on its projected cash flows. Active Management is the use of a human element, such as a single manager, co-managers or a team of managers, to actively manage a fund's portfolio. Active managers rely on analytical research, forecasts, and their own judgment and experience in making investment decisions on what securities to buy, hold and sell. Bull Market occurs when the price of a group of securities is rising or is expected to rise. Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) measures a company’s financial performance. It is used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. Enterprise Value/Sales Ratio is a financial indicator used to determine the value of a company including debt. It is equal to a company’s Enterprise Value divided by its annual sales. Free Cash Flow is the amount of cash a company has after expenses, debt service, capital expenditures, and dividends. The higher the free cash flow, the stronger the company’s balance sheet. Inflation Risk is the possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency. Momentum investing is an investment strategy that aims to capitalize on the continuance of existing trends in the market. To participate in momentum investing, a trader takes a long position in an asset that has shown an upward trending price, or the trader short-sells a security that has been in a downtrend. The basic idea is that once a trend is established, it is more likely to continue in that direction than to move against the trend. Relative Value is a method of determining an asset's value that takes into account the value of similar assets. Calculations that are used to measure the relative value of stocks include the enterprise ratio and price-to-earnings ratio. Russell 2000® Value Index measures the performance of those Russell 2000® companies with lower price/book ratios and lower forecasted growth characteristics. All indices are unmanaged. It is not possible to invest directly in an index. Tangible Book Value is the sum of all of a company’s assets, minus its liabilities and intangible assets, such as goodwill.

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