Heartland Advisors

Heartland Mid Cap Value Strategy 3Q22 Portfolio Manager Commentary

Executive Summary 

  • After an early-quarter rebound in riskier parts of the market, stocks suffered a late-quarter slide.
  • Volatility is likely to persist, as the economy continues to weaken and further pressure seems to be coming in the form of continued interest rate hikes.
  • After the late-quarter sell-off, opportunities are again presenting themselves to add high-quality companies on our “watch list.”

Third Quarter Market Discussion

The third quarter was a tale of two markets, starting with a sharp rebound in “risk on” stocks in July and early August, followed by another downturn for the broad markets in the second half of the quarter. Early on, our Mid Cap Value strategy lagged the Russell Mid Cap Value® Index, as our holdings didn’t enjoy quite the bounce that speculative and heavily indebted areas of the market experienced, owing partly to our defensive tilt. However, by the end of September, the market seemed to refocus on balance sheet strength, valuations, and the risks to company fundamentals. In this backdrop, we were able to largely close the gap versus our benchmark in the quarter while maintaining our year-to-date outperformance. 

We try not to think in months and quarters, preferring instead to focus on years. In a nutshell, though, our performance in the third quarter was a microcosm of our value proposition: The Mid Cap Value strategy may trail its benchmark in speculative rallies, but the goal is to be positioned to outperform in difficult times and in the long run.  

Don’t be surprised if those challenges persist in the short run. We don’t claim to be economic forecasters, but management teams are highlighting continued inflationary pressures and pockets of weakening demand. Companies are finally resetting earnings expectations. In September, the number of companies cutting their third quarter and full year outlook has risen materially, and this trend is expected to continue. 

Meanwhile, inflation remains a headwind to real economic growth. The economy continues to weaken, and further pressure is likely coming as history indicates that interest rates must rise to a level closer to headline inflation before it is tamed (see chart below). Though the effects of those rising rates may lag, they’re real and will likely continue to weigh on the economy. In such an environment, investors should be rewarded for owning high-quality assets with sound financing and attractive valuations.

Heartland Advisors Value Investing Personal Income vs. Retail Sales Chart

Source: FactSet Research Systems, Inc., Monthly data 1/1/1970 to 8/31/2022. The data in this chart represents the United States Federal Funds Target Rate – Yield versus Consumer Price Index (year over year change for Federal Funds versus inflation). Consumer Price index has a base of 1982-84=100 (the average of the monthly index values is 100 over the 36 months in 1982 through 1984). All indices are unmanaged. It is not possible to invest in an index. Past performance does not guarantee future results.

Attribution Analysis

Security selection continued to be the primary driver of Mid Cap Value’s performance in the third quarter. This included underperformance in the Consumer Discretionary, Consumer Staples, and Energy sectors and outperformance in Financials and Utilities.

Heartland Advisors Value Investing Materials Sector IconUtilities. Our best-performing holding in the quarter was Constellation Energy (CEG) in the utilities sector. CEG is a great example of “deep value” holding with a self-help catalyst and is the leading provider of clean energy in the U.S., derived primarily from nuclear power. Earlier this year, the company was spun-off from a prior long-term utility holding. Post spin-off, we increased our position in CEG on the belief that the company was materially undervalued and catalysts were in place to change investors’ perception. 

One of those catalysts was the August passage of the Inflation Reduction Act of 2022. Nuclear power has never benefitted from its zero-carbon emitting properties, like wind and solar. This legislation provides nuclear power plants with zero-carbon treatment, establishing a “floor” under power prices that could protect CEG from much of the potential downside swings in commodity power prices. 

Heartland Advisors Value Investing Financial Sector IconTechnology. Before the risk-on rebound early in the quarter, we were searching for opportunities to shift from our defensive stance, looking for beaten-down, high-quality “early cycle” leaders. Existing holding, Skyworks Solutions (SWKS), represents one such opportunity that was added to on weakness. 

Skyworks is one of two leading providers of radio frequency system components to smartphone makers and electronics manufacturers. With every step-up in product complexity, over the past two decades, the competitive landscape has shrunk while gross margins have increased significantly. 5G represents another such step-up, which is likely to increase how much Skyworks can make per smartphone. 

Apple is a big customer, accounting for more than half of Skyworks’ sales. That customer concentration has depressed Skyworks’ valuation over time. More recently, fears surrounding a global recession and risk to consumer demand have further pressured valuation. However, the handset business is expected to benefit from 5G content, which may help offset some macroeconomic pressures. Away from the handset business, Skyworks’ growth is expected to accelerate thanks to other secular drivers such as WIFI 6 and growth of the industrial internet (i.e., “Internet of Things”).

At a P/E of less than eight and a 2.3% dividend yield, SWKS rarely gets this cheap, making this high-quality stock compelling for long-term investors.

Heartland Advisors Value Investing Health Care Sector IconConsumer Discretionary. We also found an opportunity to add to our existing position in Advance Auto Parts (AAP) as the stock fell and the risk/reward profile improved. Advance underperformed early in the quarter as lower-quality sector peers bounced significantly. In August, shares fell further after the company reported second quarter earnings that disappointed because of weaker-than-expected same-store sales. Furthermore, management reduced its full-year earnings outlook by ~4%, citing softening consumer purchasing patterns within AAP’s “do-it-yourself” business.

The most important driver of Advance Auto’s earnings power seems to be the management team’s ability to improve margin expansion. However, the market remains myopically focused on sales growth. The margin expansion opportunity originates from the consolidation of an overly complex and inefficient distribution network. Management is planning to roll out new distribution center software through 2023 that will reduce costs, improve network productivity, and enhance customer experience through better inventory availability. 

In addition, the auto parts retailing industry tends to be less cyclical than the Consumer Discretionary sector because consumers often hold onto their used cars longer and make necessary repairs rather than buy new vehicles when their financial prospects are weakened. AAP is currently trading at less than 12 times forward earnings, well below the company’s long-term median P/E of more than 15—while having significant room to improve profitability owing to its self-help initiatives. 

Portfolio Activity  

The late-quarter market slide has created another chance to be selectively opportunistic when it comes to high-quality companies. If market volatility and the negative earnings revision cycle continues to broaden out, names on our “watch list” are likely to come into focus. 

We do not force deep value exposure into the portfolio, preferring instead to identify self-help opportunities and act when progress is evident and headwinds are clearing. One such example is Texas Capital Bancshares (TCBI), a Dallas-based middle market commercial lender with a particular focus on the four major Texas markets of Dallas-Fort Worth, Houston, San Antonio, and Austin. 

We initiated a position in the third quarter because the company could be on the verge of improving its returns and market perception. TCBI is a classic self-help story: Prior management ran the bank as a “growth at all cost” institution. When the bank was small and interest rates were at historic lows, it was easy to sustain growth by booking new loans and growing deposits regardless of the quality of either relationship. Credit problems began to percolate after the company downgraded several levered loan credits in 2019.

As the bank grew and approached a critical asset level that triggered a greater degree of regulatory burden, management engaged in a merger-of-equals between TCBI and another Texas-based bank, Independent Bank Group. While the merger was pending, the pandemic struck and the deal was called off exposing, Texas Capital’s problems to the market.  

Last year, a new CEO was brought in from J.P. Morgan Chase. He quickly exited risky loans and reoriented TCBI as a local Texas commercial lender with a niche focus on deep customer relationships. The stock trades at around 1.1 times tangible book value, compared to 1.8 times for regional banks in general. While its return on assets is below the average for its peers, in our opinion, over time TCBI will close the return gap with valuations likely to follow suit.

Looking for early-cycle and self-help opportunities remain high priorities. Until the “risk on” rebound gives way to a more sober perspective, which seems to be occurring in real time, we will remain cautious, defensive, but decisive.

Thank you for your continued trust and confidence.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Colin McWey

Colin McWey

Vice President and Portfolio Manager

Heartland Advisors Value Investing Portfolio Manager Will Nasgovitz

Will Nasgovitz

CEO and Portfolio Manager

Heartland Advisors Value Investing Portfolio Manager Troy McGlone

Troy McGlone

Vice President and Portfolio Manager

Composite Returns*


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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)

Source: FactSet Research Systems Inc., Russell Investment Group, and Heartland Advisors, Inc.
*Yearly and quarterly returns are not annualized. The Strategy's inception date is 9/30/1996. 

The US Dollar is the currency used to express performance. Returns are presented net of advisory fees and net of bundled fees and include the reinvestment of all income. 

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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

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, Inc. at the address listed below.

As of 9/30/2022 Advance Auto Parts, Inc (AAP), Constellation Energy (CEG), Skyworks Solutions, Inc (SWKS), and Texas Capital Bancshares, Inc (TCBI) 2.38%, 3.78%, 3.28%, and 1.05% of the Mid Cap Value Composite’s net assets, respectively.

The future performance of any specific investment or strategy (including the investments discussed above) should not be assumed to be profitable or equal to past results. The performance of the holdings discussed above may have been the result of unique market circumstances that are no longer relevant. The holdings identified above do not represent all of the securities purchased, sold or recommended for the Advisor’s clients.

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.

In certain cases, dividends and earnings are reinvested.

GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Separately managed accounts and related investment advisory services are provided by Heartland Advisors, Inc., a federally registered investment advisor. ALPS Distributors, Inc., is not affiliated with Heartland Advisors, 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.

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

Book Value is the sum of all of a company’s assets, minus its liabilities. Consumer Price Index (CPI) is the most widely used measure of consumer price inflation. The CPI measures the average change over time in the prices paid by urban consumers for goods and services. The Bureau of Labor Statistics (BLS) of the U.S. Department of Labor collects the CPI price information and calculates the CPI statistics. Inflation Risk is the possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency. 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. Return on Assets is a measure of the net income after taxes that a firm is able to earn as a percent of its total assets. Risk on/Risk off Theory is an investment setting in which price behavior responds to, and is driven by, changes in investor risk tolerance. Risk-on risk-off refers to changes in investment activity in response to global economic patterns. During periods when risk is perceived as low, risk-on risk-off theory states that investors tend to engage in higher-risk investments. When risk is perceived as high, investors have the tendency to gravitate toward lower-risk investments. 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 Russell Investment Group. Russell Midcap® Value Index measures the performance of those Russell Midcap® Index 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. Volatility is a statistical measure of the dispersion of returns for a given security or market index which can either be measured by using the standard deviation or variance between returns from that same security or market index. Commonly, the higher the volatility, the riskier the security.