Gabelli Q4 Letter: Gains On Cable, Liquor, And Euro StocksVW Staff
To Our Shareholders,
For the quarter ended December 31, 2013, the net asset value (“NAV”) per Class AAA Share of The Gabelli Asset Fund increased 9.2% compared with an increase of 10.5% for the Standard & Poor’s (“S&P”) 500 Index. See page 2 for additional performance information.
The fourth quarter provided a fitting end to a remarkable year. Despite recurring drama in Washington, recession in Europe, and turmoil in emerging markets, the U.S. equity market ended the year 170% above its March 2009 low, representing a compounded annual return of over 22%. Unfortunately, the past is little help in divining the future: stocks do not go up because they went up, and they do not go down because they went up. Stocks ultimately move because of changes in their fundamentals. Our job is to understand those fundamentals and balance the risk and reward of each stock selection. At any given moment, the market presents stocks that are cheap and those that are dear. Finding cheap stocks may be more difficult than it was five years ago, but this just means we need to dig a little deeper.
We are optimistic, as it appears for the first time in many years that the world is poised for a synchronized recovery. Indeed, the U.S. is entering its fourth consecutive year of expansion. The housing market is rebounding, job growth is slowly improving, and government policy, which heretofore probably has not added to growth, is unlikely to hinder the rebound as pre-election gridlock sets in. Even the geopolitical stage seems free of major conflict, though flashpoints throughout the Middle East, between China and Japan, and between Russia and its neighbors remain concerning.
Deals, Deals and More Deals
Worldwide M&A volume totaled $2.4 trillion in 2013, a decline of 6% from 2012. Fourth quarter worldwide volume was particularly disappointing, down approximately 30%. Despite this pause in deal making, the Fund benefited from a number of transactions in 2013, including Joh. A. Benckiser’s acquisition of D.E Master Blenders, ConAgra’s (0.1% of net assets as of December 31, 2013) purchase of Ralcorp, Media General’s (0.3%) merger with New Young Broadcasting, and Verizon’s (0.3%) announcement that it would purchase the 45% of Verizon Wireless owned by Vodafone (0.1%).
Financial engineering activity, on the other hand, was very strong, with 27 spin-offs completed in the U.S. and over 20 already announced for 2014. Among the 2013 spin-offs held by the Fund are News Corp. (0.4%) and CST Brands (0.2%). A key attraction of financial engineering, in our view, is that it facilitates future tax- efficient M&A. This dynamic adds to our conviction that 2014 will be a busier year for deals.
Let’s Talk Stocks
The following are stock specifics on selected holdings of the Fund. Favorable earnings prospects do not necessarily translate into higher stock prices, but they do express a positive trend that we believe will develop over time. Individual securities mentioned are not necessarily representative of the entire portfolio. For the following holdings, the percentage of net assets and their share prices stated in U.S. dollars or U.S. dollar equivalent terms are presented as of December 31, 2013, except as noted.
AMETEK Inc. (AME)(1.8% of net assets as of December 31, 2013) (AME – $52.67 – NYSE) is a leading global manufacturer of analytical instruments for the process, aerospace, and industrial markets, and a leading producer of electric motors and blowers for the floor care and outdoor power equipment markets. In the near term, the company continues to experience significant growth in its longer cycle businesses in the aerospace, power generation, and process industries. Longer term, the company continues to make acquisitions to augment growth. In the Electronic Instruments Group, AMETEK expects one half to two thirds of its revenue growth to come from acquisitions. The company is focused on acquiring differentiated businesses with revenues of $30-$100 million. Differentiated businesses compete on the basis of product capability, have higher growth rates, and offer superior returns. In the Electromechanical Group, AMETEK’s key strategy is to reduce costs by increasing efficiency and moving noncore operations to low cost countries such as Mexico, the Czech Republic, and China.
Cablevision Systems Corp. (CVC) (0.9%) (CVC – $17.93 – NYSE) provides broadband, TV, and phone service to over three million subscribers in the New York metropolitan area. An industry pioneer, CVC has developed the most advanced plant in the country and converted over 70% of its subscribers into triple play (video, phone, and broadband) customers. In the process, Cablevision achieved industry-leading average monthly subscription revenues and margins. This peak performance led the company to become a victim of its own success; combined with competition from Verizon FiOS (0.3%) in approximately half its footprint, Cablevision saw reduced growth and a sagging share price in 2012/2013. The company’s efforts to address these declines appear to be paying off. Management has also been active on the financial front, spinning off Madison Square Garden (0.7%) in February 2010 and AMC Networks (0.6%) in June 2011 and repurchasing over 10% of shares outstanding. Early in 2013, Cablevision agreed to sell its Optimum West (formerly Bresnan) systems to Charter Communications (less than 0.1%), capturing an attractive equity return. Cablevision is now a single-market, pure-play cable operator, which could facilitate an eventual consolidation of the company in our view
Chemed Corp. (CHE)(0.3%) (CHE – $76.62 – NYSE) , based in Cincinnati, OH, is a holding company that owns the Vitas hospice company and the Roto Rooter plumbing business. Vitas is the nation’s largest hospice company, with almost $1 billion in annual sales. The company is currently facing headwinds from government billing changes and a regulatory investigation, but its management is working hard to protect margins and it should begin to move beyond these issues in 2014. Roto Rooter is enjoying steady revenue growth and record profitability as the economy, particularly the housing market, improves. With strong free cash flow and modest capital expenditures, Chemed is returning the vast majority of its cash flow to shareholders via significant share repurchases.
Chemtura Corp. (CHMT)(0.1%) (CHMT – $27.92 – NYSE) is a global developer, manufacturer, and marketer of engineered specialty chemicals. Its products are used as additives, ingredients, or intermediates, serving major industries such as agriculture, building & construction, consumer, energy, electrical & electronics, transportation, and general industrial. Since its emergence from Chapter 11 in November 2010, under the leadership of Craig Rogerson, the management team has focused on actively managing its portfolio via investments in three vertical markets (transportation, electronics & energy, and agriculture), while monetizing businesses with below-target long-term potential. The recent sale of Consumer Products and the potential sale of AgroSolution (presently undervalued) continue the company’s trend toward a more focused business portfolio. Potential net proceeds of $1.2B will be used for debt reduction, share repurchasing, investments in the remaining operations, and potential bolt-on acquisitions. The remaining operations, Industrial Performance Products (petroleum additives and urethanes) and Industrial Engineered Products (bromine & flame retardants and organometallics), are expected to grow revenues via innovations, share gain, and geographic expansion, while bottom line will benefit from internal actions. In addition, market demand for flame retardants used in electronics and insulation foam applications should improve. We estimate that the “New Chemtura” (exclusive of Consumer and Ag) will generate EPS of $1.50 and $1.75 in 2015 and 2016, respectively.
Dana Holding Corp. (DAN)(0.3%) (DAN – $19.62 – NYSE) is a Maumee, Ohio-based supplier of axles, drivelines and thermal products for the automotive and trucking industries. Dana’s new CEO, Roger Wood, has begun to emphasize the company’s strong technological expertise in thermal management technology, including advanced battery cooling products for next generation vehicles. Additionally, the company is beginning to reap the benefits of efforts to improve customer pricing as well as internal manufacturing efficiencies, both of which are expected to improve margins amid robust demand in the company’s core auto and trucking markets.
Diageo Plc. (DEO)(1.1%) (DEO – $132.42 – NYSE) is the leading global producer of alcoholic beverages, with brands including Smirnoff, Johnny Walker, Ketel One, Captain Morgan, Crown Royal, J&B, Baileys, Tanqueray, and Guinness. The company has a balanced geographic presence in both mature and emerging markets, and it benefits from the trend of consumers around the world trading up to premium brand products. In 2011 and 2012, Diageo made several acquisitions that enhanced its presence in emerging markets: Mey Icki, the leading spirits company in Turkey; Shui Jing Fang, a leading Chinese baiju producer; Ypioca, the leading cachaca producer in Brazil; and an increased stake in Halico, the leading domestic spirits producer in Vietnam. Diageo also made an investment in United Spirits, the leading spirits producer in India, which will provide the company with the leading position in another fast-growing emerging market. Longtime executive Ivan Menezes took over as CEO on July 1, 2013, and we expect him to continue to drive the company’s growth in both mature and emerging markets.
Diebold Inc. (DBD)(0.2%) (DBD – $33.01 – NYSE) is a global leader in the manufacture and servicing of ATM machines. It also provides security systems and services, primarily to the financial, commercial, government, and retail markets worldwide. In June 2013, Diebold appointed former Hewlett-Packard and Siemens executive Andy Mattes as its new CEO to lead a restructuring and turnaround of its operations. Andy immediately reduced the size of the workforce and is moving to standardize business practices globally to drive efficient operations. Returning margins to historical and peer levels should enable substantial upside for Diebold. At the same time, Diebold is targeting higher-margin growth opportunities that include expanded servicing of ATMs, a broader commercial security presence across verticals, and bank branch automation. Bank branch automation is the opportunity to replace tellers with high-tech ATMs that can handle check deposit and other advanced transactions, with online video support a key enabler. Altogether, we see Diebold as capable of more than doubling earnings over the next four years, while continuing to support a strong dividend.
Genuine Parts Co. (GPC)(1.2%) (GPC – $83.19 – NYSE) is an Atlanta-based distributor of automotive and industrial replacement parts, office products, and electrical and electronic components. We expect GPC’s well-known NAPA Auto Parts group to benefit as an aged vehicle population, which includes the highest percentage of off warranty vehicles in history, helps drive sales of automotive aftermarket products over the next several years. Additionally, economic indicators remain supportive of the company’s industrial and electrical parts distribution businesses amid steady economic expansion. Finally, GPC’s management has shown consistent dedication to shareholder value via share repurchases and dividend increases.
Investment AB Kinnevik (OSTO:KINV A)(0.2%; 0.1%) (KINV’AB – SEK 299.30 – Stockholm Stock Exchange; KINV’B – SEK 297.90 – Stockholm Stock Exchange) , headquartered in Stockholm, Sweden, was established in 1936 as an investment company. Kinnevik manages a portfolio of listed holdings, primarily in the telecommunications and media sectors, including publicly traded Millicom, Tele2, Modern Times Group, CDON Group, Black Earth Farming, and Transcom Worldwide. In addition, typically through its New Ventures subsidiary, Kinnevik invests in small and mid-size companies with significant growth potential, focusing primarily on online, microfinance, and agriculture businesses. Kinnevik’s largest unlisted holding is its 36% interest in Zalando, a leading European online footwear and fashion retailer. On December 9, 2013, Kinnevik announced that it had sold its 25.1% interest in BillerudKorsnäs, a manufacturer of fiber-based packaging, to a group of Swedish institutions for approximately SEK 3.7 billion in cash. After the transaction, Kinnevik will have net cash of around SEK 3 billion. Management noted that the company’s strong financial position should support continued development of the company’s current holdings and enable Kinnevik to continue to make new investments within telecom and financial services, as well as online and media companies.
Twenty-First Century Fox Inc. (FOXA)(2.1%; 0.2%) (FOXA – $35.18 – NASDAQ; FOX – $34.60 – NASDAQ) is a diversified media company, with operations in cable network television, television broadcasting, filmed entertainment, and direct broadcast satellite television. Cable networks account for 66% of the company’s EBITDA and benefit from contractually recurring affiliate fees and exposure to the fast-growing global pay television market. We also expect the company to benefit from rising demand for premium content, driven by emerging distribution platforms such as Netflix, retransmission revenue, and aggressive share repurchases.
Xylem Inc. (XYL)(0.7%) (XYL – $34.60 – NYSE) is a global leader in the design, manufacturing, and application of highly-engineered technologies for the transportation, treatment, and testing of water. The company is expected to benefit from favorable long-term fundamentals in the water industry, driven by scarcity, population growth, aging of the infrastructure, and the need to improve water quality. Further, with a large installed base of pumps and systems, the company is well positioned to increase aftermarket revenue, which currently represents roughly 40% of total revenues. Xylem’s attractive business mix also generates strong cash flow, which is expected to support acquisitions, debt service, and dividend growth. Concerns regarding weakness in Europe and municipal spending levels in the U.S. remain, although we believe the long-term fundamentals outweigh these concerns.
Investment Scorecard The top contributors to performance for the fourth quarter included Precision Castparts (1.7% of net assets as of December 31, 2013) (+19%), Rolls-Royce (1.3%) (+18%), and Curtiss-Wright (0.7%) (+33%), each of which has benefited from a global aerospace cycle that shows no signs of slowing down. Satellite firms DIRECTV (1.5%) (+29%) and DISH Network (0.6%) (+16%) reported strong third quarter results, including positive subscriber additions; speculation about a combination of those firms continues. Other notable contributors included CVS Caremark (0.7%) (+27%) and American Express (1.6%) (+20%).
Detractors to performance included Swedish Match (1.0%) (–9%), which faced increasing competitive pressures in its cigar business on top of existing price pressure in its Swedish snus business, and Remy Cointreau (0.2%) (–21%), which experienced significant volume declines in the Chinese spirits market. Newmont Mining (0.4%) (–17%) ended the year down, in sympathy with the price of gold.
While we think economic conditions will continue to slowly improve, double-digit equity market returns cannot continue indefinitely. Volatility is likely to return, as the push and pull between rising rates and accelerating growth plays out. Our focus remains on generating superior tax-efficient, inflation-adjusted returns by relying upon our time-tested people, process and Private Market Value (PMV) with a Catalyst™ philosophy.
January 10, 2014
Note: The views expressed in this Shareholder Commentary reflect those of the Portfolio Managers only through the end of the period stated in this Shareholder Commentary. The Portfolio Managers’ views are subject to change at any time based on market and other conditions. The information in this Portfolio Managers’ Shareholder Commentary represents the opinions of the individual Portfolio Managers and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. Views expressed are those of the Portfolio Managers and may differ from those of other portfolio managers or of the Firm as a whole. This Shareholder Commentary does not constitute an offer of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this Shareholder Commentary has been obtained from sources we believe to be reliable, but cannot be guaranteed.