Heartland Opportunistic Value Equity Strategy 4Q20 Portfolio Manager Commentary

Executive Summary

  • Security selection was strong in several sectors, and the Strategy kept pace with its Russell 3000® Value Index benchmark for the period.
  • Investors continued to overlook historic levels of corporate debt as well as embrace highly optimistic forecasts.
  • Some of the areas hardest hit earlier this year rose on the belief that the recent economic resurgence would continue.

Fourth Quarter Market Discussion

Widespread investor optimism from the previous quarter was validated as a steady stream of companies reported sales and earnings that beat Wall Street expectations. The better-than-expected results provided additional fuel to a market that was buoyed by news of the development of multiple successful vaccines to combat COVID-19, and the end of the contentious presidential election.

The growing sense that a return to pre-pandemic life was on the horizon led investors to bid up cyclical areas as well as some troubled businesses with significant exposure to consumers. The euphoria caused investors to overlook near historic levels of corporate debt as well as embrace rosy forecasts that we believe are unsustainable. 

The chase of momentum and some of the biggest names in the market is counterintuitive based on previous recessions. As the chart below shows, historically, small cap companies have had outsized performance gains coming out of recessions. While we have not made a conscious effort to overweight small caps in the Strategy, our risk reward analysis on individual names has led to a meaningful portion of assets invested in smaller businesses.

Opportunity in Small Caps?
Small-Cap/Large Cap Ratio Around Post-War Recession End Dates
Source: Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/. This chart shows monthly data from 1/1/1947 to 12/31/2020. The data included in this chart is an aggregate of all recession periods noted.


Attribution Analysis

Security selection was strong in Consumer Staples, Energy and Health Care, the Strategy kept pace with its Russell 3000® Value Index benchmark for the period. Consumer Discretionary holdings were up on an absolute basis but lagged those in the broader index.

Refined taste. The view that the current economic resurgence has staying power benefited some of the areas hardest hit at the onset of the global pandemic. Energy was a prime beneficiary of the return-of-normal mindset. Our names in the space were up sharply and contained a top contributor, Holly Frontier Corp (HFC), a small independent petroleum refiner. 

The anticipated acceleration of the reopening of the global economy could translate to greater demand for petroleum products. The expectation has resulted in a sharp rise in the price of oil, gas and associated products. The return to normal should boost sales for Holly Frontier, which has begun diversifying its business into renewable diesel fuels. 

With shares priced below book value, we believe the wide gap between Holly Frontier’s stock price and intrinsic value will close as the economy returns to trend growth. Additionally, the company’s relatively strong balance sheet should allow it to weather any delays in the reopening of the economy.  

The right material. Investor confidence that the economy was recovering off depressed levels was clearly on display in the Materials sector where industrial metals and chemicals soared while miners of precious metals, which are often viewed as storehouses of value in volatile times, lagged. The portfolio’s holdings in the space outperformed the benchmark average, and we reaped the benefit of some bargain hunting completed while the economy was still reeling from being shut down.

Shares of portfolio holding Linde, plc (LIN), the world’s largest producer and distributor of industrial gasses, rose in anticipation of a recovery in demand from its end clients. We welcomed the results but view the company as a high-quality business that has a long runway for continued success ahead of it. 

Industrial gasses are utilized in a broad array of areas including health care, manufacturing, and petrochemical production. The business is attractive because gasses are generally a small percentage of the customer’s input cost, but the cost of failure is extremely high. This “low cost/high value” dynamic, combined with a rapidly consolidated market, has resulted in an industry with pricing power.  

We began monitoring Linde following its merger with a U.S.-based competitor roughly two years ago. The deal resulted in Linde becoming a global leader poised to gain market share. When shares declined in first half of the year in reaction to the COVID-induced recession, it created what we viewed as a once-in-a-decade opportunity to own an outstanding business at compelling valuations. We expect Linde’s earnings power to grow significantly due to a combination of cost cuts, recovering end markets, and investments in the business that should bolster earnings.  

 

Healthy prognosis? The portfolio’s Health Care names were up double digits during the period and outpaced the benchmark average for the group. Despite the strong showing over the past three quarters, we believe opportunities continue to exist in the space as the U.S. health system eventually returns to normal. Portfolio holding HealthStream Inc. (HSTM) is an example of our thinking.

HealthStream is a web-based education and training platform that focuses exclusively on the Health Care sector.  The company collects subscription fees based on a per-user schedule, and content creators pay a fee to the company to get content distributed. Additionally, medical device and pharmaceutical manufacturers utilize HealthStream as a training hub for those prescribing and administering medicines. The high level of training requirements for medical workers has translated into a generally stable earnings profile for the company.  

Shares of HealthStream have lagged the broader market for much of the year as the number of health care professionals nationally shrunk in response to the decision by many facilities to suspend non-emergency procedures and treatments. Additionally, the company is in the midst of a content supplier change for one of their training offerings, which is expected to cause a one-time decline in revenue. We view both issues as temporary setbacks that have resulted in a compelling investment opportunity. 

 

Portfolio Activity

The strong showing for the broad market has stretched valuations for many stocks but opportunities remain. As we scour the investing landscape, we remain fixated on valuations and identifying businesses that face a low bar for success. Our consistent process has allowed us to make upgrades to the portfolio and purchase names that traditionally have been too expensive for the Team to consider. Comcast Corp (CMCSA), a communication services giant that owns Xfinity cable, NBC Universal, Universal Pictures and Universal theme parks, fits with our approach.

Comcast has long been on our radar due to the company’s strong track record of capital allocation. The COVID-induced recession took a significant toll on Comcast’s NBC Universal unit, particularly Universal Pictures and Universal theme parks, creating a compelling opportunity to buy shares. Additionally, the company has been investing in streaming capabilities by acquiring Sky in Europe and by launching its “Peacock” streaming service, which has put pressure on margins. Combined, these headwinds caused Wall Street analysts to slash forward earnings estimates by roughly 25% during the first half of this year.

As costs tied to the launch of its streaming service peak, people head back to theme parks and movie production resumes following the rollout of a COVID vaccine, we believe Comcast will be well poised to resume its impressive earnings track record. Despite the seemingly temporary nature of the headwinds facing the company, shares of Comcast currently trade at 10x estimated 2021 enterprise value/earnings before interest, taxes, depreciation and amortization compared to a sector average at just below 12x. Historically, Comcast has traded at a 20% premium to the sector.

 
   

Outlook and Positioning

The out-sized movements in the markets caused by COVID-19 and advancements in treating the virus has resulted in some investors adopting a trade-first-analyze-later mentality. Instead of weighing opportunities based on valuations and long-term prospects, some buyers are snapping up businesses based on price momentum and blue-sky scenarios that rely on interest rates hovering near zero and inflation remaining subdued for the foreseeable future. There have been signs that valuations are starting to matter but they remain too few and far between. 

As equities have continued to recover, the pool of opportunity has narrowed. However, our team remains consistent in our approach of seeking financially sound businesses, trading at attractive valuations relative to conservative earnings estimates. While the major indices are hitting new highs, we are pleased that our active, disciplined approach has led us to companies priced at valuation discounts not seen since the bursting of the Dotcom bubble. 

Thank you for your continued trust and confidence.
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Portfolio Management Team

Colin McWey

McWey, CFA, is Vice President and Portfolio Manager for the Opportunistic Value Equity Strategy, as well as the Mid Cap Value Fund and it’s corresponding Mid Cap Value Strategy. He has 18 years of industry experience, 11 at Heartland.

Will Nasgovitz

Nasgovitz is CEO and Portfolio Manager of the Opportunistic Value Equity Strategy, as well as the Mid Cap Value Fund, the Value Fund, and their corresponding Mid Cap Value and Small Cap Value Strategies. He also is President and Director of Heartland Funds. He has 20 years of industry experience, 17 at Heartland.

Troy McGlone

McGlone, CFA, is Vice President and Portfolio Manager for the Opportunistic Value Equity Strategy, as well as the Mid Cap Value Fund and it’s corresponding Mid Cap Value Strategy. He has 12 years of industry experience, 6 at Heartland.

Composite Returns*

12/31/2020

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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Opportunistic Value Equity Composite (Net of Advisory Fees)**9.527.838.643.88-1.79-1.7917.18
Opportunistic Value Equity Composite (Net of Bundled Fees)7.435.746.541.86-3.59-3.5916.71
Russell 3000® Value7.1610.369.745.892.872.8717.21

Source: FactSet Research Systems Inc., Russell Investment Group, and Heartland Advisors, Inc.
*Performance data is preliminary. Yearly and quarterly returns are not annualized. The Strategy's inception date is 9/30/1999. 
**Shown as supplemental information. 

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. The returns net of bundled fees were calculated by subtracting the highest applicable sponsor portion of the separately managed wrap account fee from the net of advisor fees return.

©2021 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

†Composite return is net of advisory fees.

Past performance does not guarantee future results.

The Opportunistic Value Equity Strategy seeks to capture long-term capital appreciation by investing in companies with market capitalizations greater than $500 million. The Strategy’s flexible pursuit of value positions it as a core holding for investors.
 

In addition to stocks of large companies, the Opportunistic Value Equity Strategy invests in stocks of small- and mid-cap companies that are generally less liquid than large companies. The performance of these holdings generally will increase the volatility of the strategy’s returns.

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 Institutional Sales at Heartland Advisors, Inc. at the address listed below.

As of 12/31/2020, Comcast Corp., HealthStream Inc., Holly Frontier Corp., and Linde plc, represented 2.74%, 0.92%, 1.68%, and 2.49% of the Opportunistic Value Equity Composite, respectively.  

Statements regarding securities are not recommendations to buy or sell.

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

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 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.

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.

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.

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.

CFA® is a registered trademark owned by the CFA Institute.

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 2020 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

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

Bear Market occurs when the price of a group of securities is falling or is expected to fall. Book Value is the sum of all of a company’s assets, minus its liabilities. Cyclical Stocks cover Basic Materials, Capital Goods, Communications, Consumer Cyclical, Energy, Financial, Technology, and Transportation which tend to react to a variety of market conditions that can send them up or down and often relate to business cycles. Enterprise Value/Earnings Before Interest, Taxes, Depreciation, and Amortization (EV/EBITDA) Ratio is a financial indicator used to determine the value of a company and is calculated by dividing the entire economic value of the company (enterprise value) by its earnings before interest, taxes, depreciation, and amortization (EBITDA). Ibbotson Small Cap Total Return Index represents the fifth capitalization quintile of stocks on the New York Stock Exchange from 1926 to 1981. All indices are unmanaged. It is not possible to invest directly in an index. Intrinsic Value is the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Russell 2000® Index includes the 2000 firms from the Russell 3000® Index with the smallest market capitalizations. All indices are unmanaged. It is not possible to invest directly in an index. Russell 3000® Value Index measures the performance of those Russell 3000® Index companies with lower price/book ratios and lower forecasted growth characteristics. S&P 500 Total Return Index is calculated intraday by S&P based on the price changes and reinvested dividends of the S&P 500 Index with a starting date of 1/4/1988. 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. 

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