Heartland Advisors

Heartland Small Cap Value Plus Strategy 1Q25 Portfolio Manager Commentary

Executive Summary

  • The Heartland Small Cap Value Strategy continued to outperform, beating its benchmark in the first quarter and over the past 1, 3, and 5 years.
  • The macroeconomic outlook may be unclear, but focusing on the micro reveals how much value there is in this market. 
  • Identifying opportunities amid widespread fear is what active management is all about, and stock selection continues to drive our results. 

First Quarter Market Discussion

Recently, we have been focusing our attention on companies with two levers of potential growth. These are businesses proactively taking steps to improve their own financial strength and competitive standing to boost their profitability. Once demand dynamics improve, these firms should be better positioned to take advantage of accelerating growth, lifting their profitability even more. At the end of last year, hopes for that economic lever grew amid widespread belief that stimulative fiscal policies and reduced regulations espoused by the incoming administration would set the stage for a growing economy. 

In the first quarter, however, those assumptions were put on hold, as fears over a global trade war clouded the business climate. Adding to the uncertainty, many companies have been holding off making big investments and new hires amid the flurry of new policies being proposed by Washington, including the enactment of tariffs and significant federal spending cuts. 

U.S. GDP is now expected to shrink 2.4% in the first quarter, according to the Federal Reserve Bank of Atlanta’s GDPNow forecasting model, after growing 2.3% in the fourth quarter of 2024 and 3.1% in the third. This turn of events has been particularly hard on small stocks, with the Russell 2000® Index down 9.5% in the quarter versus the 4.3% loss for the S&P 500 Index.

It is difficult to tell whether slowdown fears will persist. But as it is becoming harder to rely on demand dynamics improving, even greater emphasis will be placed on companies that are successfully undertaking “self-help” strategies to improve their standing. Even if these businesses only tread water for the time being, that could be considered a temporary victory in the current environment. 

This also places greater importance on the need for a balanced approach. The range of possible economic outcomes widened at the start of the year. An example of this can be seen through one of our holdings, FirstCash Holdings, Inc., a leading operator of pawn shops and lending locations geared toward credit-constrained consumers. As the chart below shows, the company’s pawn loan balances have risen considerably in recent quarters.

Source: Heartland Advisors, Inc., FirstCash Holdings, Inc.(FCFS) Financial Statements. Quarterly data from 3/31/2022 to 12/31/2024. This chart represents the Pawn Loan Balances of FCFS on a quarterly basis ($mm). Past performance does not guarantee future results.

As these are a lending source of last resort, this would suggest lower-income consumers are stretched. This alone may not be enough to trigger a ‘risk-off’ view of the market, but it does indicate the need to be cautious. Whether we are playing offense or defense, we continue to look for companies embracing ‘self-help’ that also adhere to our 10 Principles of Value Investing™, which focus on attractively priced, well-managed companies with high-quality balance sheets, low debt, and positive earnings dynamics. 

Attribution Analysis & Portfolio Activity

The Value Plus Strategy lost 8.22% in the first quarter, compared with the 7.7% decline for the Russell 2000® Value Index. Stock selection was positive in four sectors, led by Real Estate, Energy, Industrials, and Utilities. Not surprisingly, those segments of the market accounted for eight of the ten top stocks contributing to our Strategy’s returns in the first quarter. 

A key focus of our selectivity has been driven by self-help. An example is The Hanover Insurance Group, Inc. (THG), a property and casualty insurer. The company stumbled in recent years, thanks to heavy exposure to the upper Midwest, which has been hit with severe weather including deadly hailstorms. After falling short of earnings estimates recently due to the cost of damaging storms, the company has been taking steps to reduce its exposure to catastrophic events — for instance by writing less insurance in at-risk geographies and raising deductibles. THG has also made other money-saving moves, such as requiring customers to use sensors for early detection of water leaks in their homes. Those efforts led to strong fourth quarter results. In Q4, catastrophic losses contributed just 2.1% of Hanover’s combined ratio, a key measure of profitability. That was substantially less than it has been in recent years.

Meanwhile, Hanover has restructured its investment portfolio, which accounts for 60% of its earnings, to benefit from higher yields. This should go a long way toward boosting its net investment income this year. Yet despite these positive steps, the stock, with a steadily growing dividend, still trades at approximately 12 times 2025 earnings per share.

Another defensive holding is FirstCash Holdings Inc. (FCFS), a leading operator of pawn shops in the U.S. and Latin America whose core driver of earnings is pawn loan balances. But unlike THG, which can thrive despite economic circumstances, FirstCash is positioned to do well because of the challenging economy.

Traditionally, when the consumer discretionary sector is doing poorly, as was the case in the first quarter, FirstCash often has done well. In the first quarter, the stock rose over 16.5%, making it among the top performers among our holdings. Stretched by inflation, consumers are increasingly utilizing pawn loans to cover their financial needs. Contrary to popular belief, though, pawn businesses have limited credit risk, as companies can simply keep the collateral items being held if consumers fail to pay back their loans. The stock is trading at nearly 15 times earnings and just 11 times EBITDA with a growing dividend and an active buyback program in place. We believe this valuation represents a material discount to its historical multiple.

We consider Gates Industrial Corporation plc (GTES), one of the leading global manufacturers of belts and hoses used in vehicles and industrial machines, to be an all-weather stock set up to perform well relative to small-cap Industrials in all types of macro environments. Yet the shares have fallen 21.7% since Feb. 19 along with the entire Industrial sector amid concerns of a trade war.

Ironically, the company’s biggest end market is auto replacement parts, representing 36% of sales. The threat of tariffs significantly boosting the overall price of new cars should make consumers hold onto their existing vehicles longer, which should be good for Gates. If the macro environment deteriorates, we believe the company will face less downside pressure than most Industrials owing to the large percentage of revenues it derives from the less-cyclical replacement markets. On the other hand, should the macro environment improve, Gates could see significant revenue upside as cyclical Industrial end-markets have been pressured by a weak economy for multiple quarters. 

The company’s recent self-help efforts have also led to margin improvement through material cost reduction and footprint optimization. Those moves should help offset any margin pressure that could occur from end-market weakness. The company appears to have significantly improved its balance sheet, with leverage currently at 2.2 times net debt to EBITDA, down from its pre-COVID-19 levels of 3-4 times. At this current leverage profile, Gates should be positioned to return more of its free cash flow to shareholders in the form of share repurchases. Yet the stock trades at just 13 times earnings and 9 times EBITDA, which is relatively low compared to other Industrial businesses with a similar margin profile. 

Outlook

We believe this is a market that requires patience and a long-term mindset. Ideally, we would love to take advantage of the one-two punch of self-help strategies setting up companies for faster earnings growth once demand dynamics improve. The fact that this second punch has less sting today does not detract from the overall strategy — it simply puts greater emphasis on companies that are doing what they can to strengthen their own position. That is why our 10 Principles of Value Investing™ are more important than ever in times like these, as traits such as attractive prices, high-quality balance sheets, and competitive advantages are useful regardless of economic conditions.
 

Thank you for your continued trust and confidence in us.
    

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Andrew Fleming

Andrew J. Fleming

Director of Research, Vice President, and Portfolio Manager

Composite Returns*

3/31/2025

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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Small Cap Value Plus Composite (Net of Advisory Fees)**6.335.2910.70-2.22-9.39-8.10-8.10
Small Cap Value Plus Composite (Net of Bundled Fees)5.144.068.67-4.88-15.77-8.22-8.22
Russell 2000® Value6.636.0715.310.05-3.12-7.74-7.74

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 11/30/2007. 
**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.

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Past performance does not guarantee future results.

The Small Cap Value Plus Strategy primarily invests in companies that have a market capitalization consistent with the capitalization range of the Russell 2000 Value Index, with a majority of its assets invested in companies that pay dividends. The Strategy intends to capture the long-term appreciation of small-caps, while minimizing the volatility of returns inherent in the small-cap market.

The Small Cap Value Plus Strategy invests in small companies selected on a value basis. Such 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 3/31/2025, FirstCash Holdings Inc. (FCFS), Gates Industrial Corporation plc (GTES), and The Hanover Insurance Group, Inc. (THG), represented 2.41% 2.68%, and 3.64% of the Small Cap Value Plus 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 holdings are subject to risk.

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.

In certain cases, dividends and earnings are reinvested.

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 2025 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

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

Artificial intelligence (AI) is intelligence—perceiving, synthesizing, and inferring information—demonstrated by computers, as opposed to intelligence displayed by humans or by other animals. Dividend Yield is a ratio that shows how much a company pays out in dividends each year relative to its share price.  Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) measures a company’s financial performance. It is used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. Free Cash Flow is the amount of cash a company has after expenses, debt service, capital expenditures, and dividends. The higher the free cash flow, the stronger the company’s balance sheet. Leverage is the amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged. Operating Leverage is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. A business that makes sales providing a very high gross margin and fewer fixed costs and variable costs is considered to have high leverage. The higher the degree of operating leverage, the greater the magnitude of changes in sales to potential profits. 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 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 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. S&P 500 Index is an index of 500 U.S. stocks chosen for market size, liquidity and industry group representation and is a widely used U.S. equity benchmark. All indices are unmanaged. It is not possible to invest directly in an index. 10 Principles of Value Investing™ consist of the following criteria for selecting securities: (1) catalyst for recognition; (2) low price in relation to earnings; (3) low price in relation to cash flow; (4) low price in relation to book value; (5) financial soundness; (6) positive earnings dynamics; (7) sound business strategy; (8) capable management and insider ownership; (9) value of company; and (10) positive technical analysis.

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