Heartland Mid Cap Value Strategy 3Q19 Portfolio Manager Commentary

Executive Summary 

  • Stock selection was strong in several areas but the portfolio lagged its Russell Midcap® Value benchmark returning -0.44%†  versus 1.22%. 
  • Investors seeking income once again poured into Real Estate Investment Trusts (REITs) and Utilities.
  • The cumulative effect of our bottom−up approach is a portfolio that is less economically sensitive than in the recent past.

Third Quarter Market Discussion

The major indices spent much of the quarter buffeted by dramatic and frequent shifts in investor sentiment. The markets surged or retreated based on the latest trade war tweets and interpretation of economic data. Macro themes ruled for much of the period and fundamentals of individual stocks were largely overlooked.
 
An uncertain outlook led to a volatile quarter for equities, yet the major indices ended the period up modestly following a late−period uptick in economic confidence. 
 
Investors sought refuge from economic uncertainty by favoring large companies over small and, as the chart below shows, steadier−performers over their more−volatile peers.
 
Clamoring for Calm

Heartland Advisors High Beta/Low Volatility

Source: FactSet Research Systems Inc., Standard & Poor’s, and Heartland Advisors, Inc., 1/2/2018 to 9/30/2019
High Beta/Low Volatility is represented by the relative performance of the S&P 500 High Beta Index versus the S&P 500 Low Volatility Index. All indices are unmanaged. It is not possible to invest directly in an index.
Past performance does not guarantee future results.

Concerns about future growth weighed on Treasury yields, and investors seeking income once again poured into Real Estate Investment Trusts and Utilities despite elevated valuations. 
 
Attribution Analysis
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. 
 
Heartland Advisors Value Investing Health Care Sector IconHungry for more? 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.
 
Dented metal. 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. 
 
Heartland Advisors Value Investing Information Technology Sector IconEnergized. 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.
 

Portfolio Activity

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. 
 

Outlook and Positioning

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.

 

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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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Colin McWey

Colin McWey

McWey, CFA, is Vice President and Portfolio Manager of the Select Value and Mid Cap Value Funds and their corresponding separately managed account strategies. He has 17 years of industry experience, 10 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 CEO of Heartland Funds. He has 19 years of industry experience, 15 at Heartland.

Composite Returns*

9/30/2019

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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Mid Cap Value Composite (Net of Advisory Fees)11.2111.437.748.810.5816.17-0.44
Russell Midcap® Value10.3512.297.557.821.6019.471.22

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

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©2019 Heartland Advisors | 789 N. Water Street, Suite 500, Milwaukee, WI 53202 | Business Office: 414-347-7777 | Financial Professionals: 888-505-5180 | Individual Investors: 800-432-7856

†Composite returns are net of advisory fees.
*Performance data is preliminary. Yearly and quarterly returns are not annualized. The Strategy's inception date is 9/30/1996.

The U.S. dollar is the currency used to express performance.

Past performance does not guarantee future results.

The Mid Cap Value Strategy seeks long-term capital appreciation by investing in mid-size companies as defined by the market capitalization range of the Russell Midcap® Index. This focused portfolio seeks companies with strong underlying business franchises priced at a discount to their intrinsic worth that have temporarily fallen out of favor.

The Mid Cap Value Strategy invests in mid–sized companies on a value basis. Mid-sized 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.

Heartland Advisors, Inc. (the "Firm") claims compliance with the Global Investment Performance Standards (GIPS®). The Firm is a wholly owned subsidiary of Heartland Holdings, Inc., and is registered with the Securities and Exchange Commission. For a complete list and description of Heartland Advisors composites and/or a presentation that adheres to the GIPS® standards, contact the Institutional Sales Team at Heartland Advisors.

As of 9/30/2019, Bunge Limited, Cleveland-Cliffs Inc., Mohawk Industries, Inc., Sanderson Farms, Inc., and TechnipFMC PLC represented 2.53%, 1.18%, 1.53%, 1.86%, and 2.87% of the Mid Cap Value of the Mid Cap Value Composite, respectively. 

Portfolio holdings are subject to change without notice. Current and future portfolio holdings are subject to risk.

Statements regarding securities are not recommendations to buy or sell.

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.

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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.

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