Heartland Advisors

Heartland Value Plus Fund 2Q22 Portfolio Manager Commentary

Executive Summary

  • Stocks slid into a bear market amid rising rates and inflation, and now investors seem to be wondering whether Federal Reserve rate hikes might trigger a recession.
  • Against this backdrop, we believe it’s more important than ever to focus on well-run, quality businesses with strong balance sheets.
  • The big question is when will investor concerns rise to the point where they start demanding balance sheet strength?

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

Nervous investors entered the quarter waiting for another shoe to drop, and it did. As the Federal Reserve aggressively raised interest rates to cool inflation that’s been running hotter than in four decades, stocks fell into an official bear market. Now, those same investors are wondering whether the force with which the Federal Reserve has slammed on the brakes of monetary policy might drive the economy into recession.

But with consumer confidence sinking and consumer credit exploding, that question may be moot. The consumer economy appears already to effectively be in a downturn, and that is  resetting the market’s expectations. From our perspective, the real next development to watch out for is the point when market anxieties rise to where investors finally begin to focus on balance sheet strength again, as they did briefly in the first quarter of 2020 at the start of the COVID-19 recession and in 2007 at the start of the global financial panic. 

In our opinion, we’re not there yet, but we are paying close attention as this would signal the next leg in the downturn, which we think will refocus attention on attractively priced and well-managed companies with high-quality balance sheets that enjoy a margin of safety from both an operational and valuation standpoint.

The Best Offense May Be a Good Defense

Given this economic backdrop, we don’t anticipate strong equity market performance for some time. Yet history has shown that active managers can find promising opportunities in otherwise weak markets. Many pockets of the small-cap universe, for instance, outshined large-caps for several years in the 1970s against a weak economic backdrop. And value outperformed the broad indexes in the years immediately following the bursting of the dotcom bubble. Today’s economy is not an exact repeat of those periods. Nevertheless, we believe we’re in another stock picker’s market. 

What traits should stock pickers be looking for? Balance sheet strength is always our first consideration, even ahead of income statements, because we approach companies like credit analysts. In the current environment, this mindset seems to be particularly useful as we believe the markets are about to enter a period of negative earnings revisions, as analyst estimates still seem far too optimistic. In effect, investors will likely have difficulty identifying corporate earnings—or the “E” in the price/earnings ratio— so investors shouldn’t let P/E ratios be their primary guide. Moreover, the percent of stocks that are unprofitable has hit a record high. (see the chart below)

Growing Negative Earnings

Heartland Advisors Value Investing Total Market Cap to GDP Chart

Source: Kailash Capital, LLC, Yale University, Compustat. https://kailashconcepts.com/. The chart above shows the percent of Russell 2500 Firms with negative earnings. Monthly data from 12/31/1978-6/30/2022. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

Our view is that if credit markets tighten, as one would expect in a recession, companies that can self-finance their growth stand to be far more attractive. That’s why we prefer well-managed companies with strong balance sheets and consistent free cash flow generation. This is also why we tend to prefer dividend payers and growers—though not the highest yielders—because the ability to consistently boost dividends, even in difficult economic times, signals management’s skills at capital allocation.

For similar reasons, we prefer companies with little or no leverage, which is a constant in our Ten Principles of Value Investing™. While the markets haven’t been rewarding companies with low leverage, that could soon change in today’s “risk off” market, especially if the economy takes another leg down. In June, the median net debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio for our portfolio stood at just 0.7 times, versus around 2.3 times for our benchmark. That gap between our net debt-to-EBITDA ratio and that of our benchmark is the widest it has been in nearly four years.

Attribution Analysis

Even with multiple layers of safety nets, strong balance sheets and cash flow generation, investors likely can’t protect against stock market losses in the short term. In the second quarter, for instance, the portfolio was down slightly, though less than the Russell 2000 Value Index, thanks in part to stock selection and a focus on quality.

Heartland Advisors Value Investing Consumer Discretionary Sector IconIndustrial Strength. To address inflation in the long-term, we believe the economy will need to expand capacity through reshoring industrial production back to the United States. Several of our holdings are likely to benefit if this theme unfolds. Powell Industries (POWL), for instance, develops, manufactures, and services custom-engineered equipment systems used in oil and gas refining, mining and metals, electric utility, and other heavy industrial markets.

Until the recent quarter, Powell shares seemed to be acting like they were in their own mini recession after running up against a series of headwinds, including the COVID-19 shutdowns, supply chain problems as the economy reopened, and inflation in the post-COVID-19 environment. While the company has been working its way back to profitability, the stock has been trading below book value with an attractive dividend yield. This past quarter, Powell enjoyed very strong bookings, a proxy for future revenues, while benefiting from the tailwind of the infrastructure build out while also being able to raise prices.

Heartland Advisors Value Investing Consumer Discretionary Sector IconHealthy Healthcare. Like Powell, many of Healthcare stocks never benefitted from the post COVID-19 rally in the stock market. As a result, our Healthcare stocks are among our cheapest holdings. Haemonetics (HAE) and Phibro Animal Health (PAHC) are two good examples. Haemonetics, which provides disposables and devices used for blood and plasma collection, appears to be a recession friendly stock as its products are not economically dependent. Moreover, as households feel economic pressures, they are more likely to donate plasma, for which they are compensated.

Phibro’s strength lies in its animal-health related franchise, with medical feed additives and nutritional products for production animals. The company is also working on early-stage opportunities in its companion pet business, which could not only diversify its revenues but potentially provide a catalyst for the stock. Phibro is trading at only around 1x sales, and the stock has enjoyed insider buying.

Outlook and Positioning

We believe we are well positioned for the current environment. Well before this past quarter, we began looking for opportunities among beaten-down high-quality stocks with defensive attributes. If we hit rockier shores, the attractive valuation of such companies should provide some downside protection. And if the credit markets begin to shut down, such holdings shouldn’t need access to debt financing to fund themselves.

This speaks to the nature of our portfolio. In great times, we try to exceed expectations. In not-so-great times, we try to win by avoiding big drawdowns. And in all types of markets, we seek out investments demonstrating financial strength, capable management teams with sound capital allocation policies, and solid business strategies at attractive prices—all of which is more possible now, after the downturn, than a year ago.

Thank you for the opportunity to manage your capital.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Bradford A. Evans

Bradford A. Evans

Senior Vice President and Portfolio Manager

Heartland Advisors Value Investing Portfolio Manager Andrew Fleming

Andrew J. Fleming

Director of Research, Vice President, and Portfolio Manager

Fund Returns


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Since Inception (%)20-Year (%)15-Year (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD* (%)QTD* (%)
*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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©2023 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 5/1/2023, the Gross Fund Operating Expenses for the investor and institutional class of the Value Plus Fund are 1.22% and 1.01%, 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 6/30/2022, Haemonetics (HAE), Powell Industries (POWL), and Phibro Animal Health (PAHC) represented 4.01%, 2.40% and 3.63% of the Value Plus Fund’s net assets, respectively. 

Statements regarding securities are not recommendations to buy or sell.

Portfolio holdings are subject to change. Current and future 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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Data sourced from FactSet: Copyright 2023 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

Bear Market occurs when the price of a group of securities is falling or is expected to fall. Inflation Risk is the possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency. Net Debt/EBITDA Ratio is calculated as a company's interest-bearing liabilities minus cash or cash equivalents, divided by its EBITDA, and is a leverage measurement that shows how many years it would take for a company to pay back its debt if net debt and EBITDA are held constant. If a company has more cash than debt, the ratio can be negative. Price/Earnings Ratio of a stock is calculated by dividing the current price of the stock by its trailing or its forward 12 months’ earnings per share. 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.

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