Heartland Opportunistic Value Equity Strategy 2Q19 Portfolio Manager Commentary

Executive Summary

  • The Strategy mildly lagged its benchmark, the Russell 3000® Value Index, returning 3.22%† versus 3.68%.
  • An escalation of long-simmering trade tensions added to concerns that the economy was running out of room to expand.
  • Volatility has provided opportunities to upgrade the quality of a portfolio as well as to find attractive bargains in lesser-known names. 

Third Quarter Market Discussion

Investors spent the period grappling with lackluster economic data and on−again, off−again optimism regarding U.S.−China trade negotiations. The uncertain outlook led to a volatile quarter for equities, yet most of the major indices ended the period up modestly.

With no clear narrative in place for what the economy holds in the near term, investors sought to hedge their bets. In a quest for calm, they favored large companies over small and, as the chart below shows, steadier−performers over their more−volatile peers.

Clamoring for Calm

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.
 
Treasury yields remained low in response to continued concerns about future growth, and investors seeking income once again poured into Real Estate Investment Trusts and Utilities despite rich valuations.
 

Attribution Analysis

Security selection was strong in Real Estate and Materials but could not overcome weakness in Information Technology (IT) and Consumer Discretionary, and the portfolio lagged its benchmark, the Russell 3000® Value Index. Allocation decisions also detracted from performance.
 
 A chicken in every pot. The portfolio’s Consumer Staples holdings were up on an absolute basis, and the group contained a key contributor, Sanderson Farms, Inc. (SAFM), the third−largest producer of fresh chicken in the U.S.  
 
A few years ago, Sanderson was riding high. Chicken prices in mid−2017 were nearly double the five−year average. As profits gapped higher, many producers added capacity to keep up with demand. However, the resulting surge in supply put pressure on pricing, and shares of Sanderson and its peers weakened.
 
In response to soft pricing, Sanderson has focused on growing its business and improving its already impressive efficiency level. The company’s rock−solid balance sheet and expertise as a low−cost producer gives it a competitive advantage, in our view. 
 
As chicken prices have rebounded, profits have jumped, and the company could now earn as much as $5 per share for fiscal 2019. That outlook is a drastic contrast to Street estimates at the beginning of the year, which forecasted just $1 for the same period. We have been pleased with the appreciation in share price and believe the company remains an appealing investment given its financial position and the potential for further sales growth in China.
 
Heartland Advisors Value Investing Consumer Staples Sector IconA haircut in discretionary. Despite the threat of higher tariffs and an unsettled economic outlook, Consumer Discretionary stocks finished the period up modestly. Our holdings in the space lagged the benchmark average and included a key detractor, Mohawk Industries Inc. (MHK), one of the world’s largest manufacturers of commercial and residential flooring.

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 its LVT production continues to ramp up, we expect investors will reward the company for improved margins and sales and valuations will be more in line with its building−product peers, which are currently trading at about 16.5x earnings.
 
Heartland Advisors Value Investing Financials Sector IconClinical approach. Health Care names in the benchmark and portfolio struggled this quarter, but the sector contained a key contributor for the strategy. Long−time holding CVS Health Corp. (CVS), a national pharmacy and health services company, was up as investors began to embrace its model of offering value−based care at its retail locations. The move began in earnest with CVS’ 2017 acquisition of Aetna, a healthcare benefits company. 

The purchase of Aetna gave CVS access to a significant pool of potential customers that it could serve at retail locations. Initial reactions to the merger were lukewarm due to the complexity of the transaction and the meaningful financial and operational risk tied to the deal. Recently, lingering concerns were eased as the company reported better than expected results and a judge removed the final hurdle standing in the way of the merger going through.
 
While investors have begun to give CVS credit for its ongoing transformation into an integrated health−care services provider, the stock remains meaningfully undervalued based on our conservative estimates. We expect that gap to close further in the coming quarters. 
 

Portfolio Activity

We have sought to maintain a balanced approach in the face of heightened volatility by selling names that are approaching our estimates of intrinsic value and opportunistically buying market leaders we view as being oversold. 
 
For example, we initiated a position in Weyerhaeuser Company (WY), a real estate investment trust (REIT) that is one of the world’s largest owners of timberland with over 12.2 million acres in the U.S., as well as a manufacturer of wood products. Shares of the trust have been under pressure since the boom in lumber prices ended last year. 
 
With timber having bounced off recent lows, we believe the worst may be behind Weyerheuser. We expect earnings before interest, taxes, depreciation and amortization to begin to inflect higher in the coming quarters. Based on a sum−of−the−parts analysis, shares of the REIT are trading at a discount based on our team’s conservative outlook for an improving end market for lumber. We also believe Weyerheuser’s 5.1% dividend yield make it an attractive holding in an environment of low−yielding bonds.  
   

Outlook and Positioning

Mixed economic data and uncertainty about when or how ongoing trade disagreements will be resolved highlight the need for a balanced, disciplined investment approach. We believe elevated volatility could endure in the coming months. That can bring opportunities—for example, the names we noted above as “oversold” in our view—but we believe it’s vital to avoid jumping into a position just because selling pressure has created somewhat more attractive valuations. Buying a name too early carries a substantial downside risk. In our view, the prudent course is to get past a fear of missing out on upside potential and stay focused on company−specific factors. 
 
Thank you for your continued confidence.

 

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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.

Heartland Advisors Value Investing Research Analyst Troy McGlone

Troy McGlone

McGlone, CFA, is Vice President and Portfolio Manager of the Opportunistic Value Equity Strategy. He has 11 years of industry experience, 5 at Heartland.

Composite Returns*

6/30/2019

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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Opportunistic Value Equity Composite (Net of Advisory Fees)**10.1312.026.9212.176.0213.773.22
Opportunistic Value Equity Composite (Net of Bundled Fees)8.039.854.839.983.9512.672.70
Russell 3000® Value7.1113.147.3110.197.3416.053.68

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 return is net of advisory fees.

*Performance data is preliminary. Yearly and quarterly returns are not annualized. The Strategy's inception date is 9/30/1999. 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.

**Provided as supplemental information.

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

Past performance does not guarantee future results.

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 the Institutional Sales Team at Heartland Advisors.

As of 6/30/2019, Amazon.com, Inc., Bank of New York Mellon Corporation, Dentsply Sirona Inc., FedEx Corporation, and Walmart Inc. represented 0.00%, 1.49%, 2.42%, 0.89%, and 1.88% 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.

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.

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.

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

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

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.

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