Diamond Hill Small Cap Fund Q2 Letter To InvestorsVW Staff
Diamond Hill Small Cap Fund increased 6.16% (Class I) during the quarter, compared to a 2.05% increase in the Russell 2000 Index.
During the quarter, Diamond Hill Small Cap Fund’s holdings in the industrials, energy, and financial sectors provided the largest contribution to absolute return. No sectors detracted from return.
The Fund’s outperformance relative to the Russell 2000 Index was primarily the result of security selection in the industrials, financial, and health care sectors as well as an overweight position in the energy sector.
Diamond Hill Small Cap Fund: Best Performers
- Auto rental company Avis Budget Group Inc. (NASDAQ:CAR) reported strong quarterly results, and pricing appeared to be in line with management’s plans in the important summer months. We estimate the company could generate $4 per share in free cash flow per share in 2015. In addition, competitor Hertz announced a multi-period earnings restatement, potentially reducing the probability that one of Avis’s two main competitors will take more aggressive pricing actions.
- Oil and gas exploration and production company Rosetta Resources Inc. (NASDAQ:ROSE) rose in anticipation of an ease in regulations on the exportation of condensate, an ultra-light oil that undergoes minimal processing. This could allow the condensate to be exported at higher prices, alleviating a potential condensate glut in the U.S. and benefitting Rosetta.
- Oil and gas exploration and production company Cimarex Energy Co (NYSE:XEC) rose as a result of an improving outlook for domestic oil prices as well as continued strong operational results in core areas. In addition, the company continued to see strong results as it tests the resource potential associated with its acreage position in the Delaware Basin.
- Railroad service company Trinity Industries Inc (NYSE:TRN) reported better than expected revenue and profitability based on continued strength in demand for tank cars coupled with a meaningful positive impact from a large new customer (Element Financial).
- Freight transportation management company Hub Group Inc (NASDAQ:HUBG) rose as investors began to focus on margin improvement opportunities due to indications of improving intermodal pricing as well as company-specific cost improvement initiatives.
Diamond Hill Small Cap Fund: Worst Performers
- Online auction marketplace service provider Liquidity Services, Inc. (NASDAQ:LQDT) lost a 2015 rolling stock Department of Defense contract but was the winner of the non-rolling stock contract. However, its winning bid of 4.35% was much higher than the historical contracted rate of 1.8%. This will considerably raise the cost of goods sold of its non-rolling stock segment, thus having a material impact on its profitability.
- Consumer products and services company Steiner Leisure Ltd (NASDAQ:STNR) declined after the company reported its first quarter earnings. The company did not repurchase shares during the quarter despite declines in its stock price following the late 2013 announcement of a non-renewal by Celebrity Cruise Lines. In addition, the quarter reflected continued weakness in the company’s Ideal Image laser hair removal business. Later in the quarter, the company announced a 10b5-1 plan under which the company can repurchase shares according to a pre-set plan.
- Shares of oil and gas exploration and production company Contango Oil & Gas Company (NYSEMKT:MCF) fell, reflecting disappointing results from an exploration well in the Gulf of Mexico.
- Lift truck manufacturer Hyster-Yale Materials Handling Inc (NYSE:HY) declined after the company provided qualitative guidance for the remainder of 2014 that may have been viewed negatively by some investors. Revenues and pre-tax income both increased during the quarter, but after-tax net income declined as a result of a higher tax rate.
- Information processing company DST Systems, Inc. (NYSE:DST) declined as the company conducted a secondary offering of common stock for a selling shareholder, Argyros Group.
Diamond Hill Small Cap Fund: New Positions
We initiated a new position in Aircastle Limited (NYSE:AYR), an aircraft leasing company with a flexible business model and a rational capital allocation philosophy. We took advantage of an opportunity to purchase shares in the heavily capitalized Georgia bank State Bank Financial Corp (NASDAQ:STBZ) as the depressed stock price reflected investors’ lack of patience with a slower than expected pace of capital deployment. We like State Bank’s management team led by Georgia banker Joe Evans. This management team has experience successfully building and selling other Georgia banks. We also received shares of transportation infrastructure company XPO Logistics Inc (NYSE:XPO) as a result of its acquisition of holding Pacer International, Inc.
Diamond Hill Small Cap Fund: Eliminated Positions
Pacer International Inc (NASDAQ:PACR) was acquired by XPO Logistics, Inc. which remains in our portfolio. We eliminated our position in specialty pharmaceutical company Actavis plc (NYSE:ACT) as the price to intrinsic value relationship narrowed. We originally received shares when Actavis bought portfolio holding Warner Chilcott. We eliminated our position in convenience store distributor Core- Mark Holding Co., Inc.( CORE) as the stock rose almost 40% over the last year and reached our estimate of intrinsic value.