Longleaf Partners

Longleaf Partners Down In Q3: FDX, BRK Biggest Gainers

Longleaf Partners Fund declined 3.4% in the quarter as macro pressures, including lower energy prices, impacted a handful of our holdings. The S&P 500 Index advanced 1.1%. Importantly, increased market volatility created several buying opportunities for the Fund, reducing the cash position that has dampened absolute and relative year-to-date (YTD) results, which were 3.4% versus 8.3% for the Index. In the bull market of the last five years, the Fund exceeded our absolute return goal of inflation plus 10%. Over longer-term periods of 15+ years, the Fund outperformed the Index.

Longleaf Partners

Longleaf: FedEx, Berkshire Hathaway the largest contributor for the quarter

FedEx Corporation (NYSE:FDX), the largest contributor for the quarter and a major contributor YTD, rose 7% and 13% respectively. The company reported strong operating results led by Ground, where revenue grew 8% year-over-year and operating margins expanded toward 20%. Express had healthy U.S. volumes, and Freight saw both volume and revenue increases. While Ground remains the majority of our appraisal, Freight’s results were notable with 70% operating income growth and double-digit margins. Sustained operating performance in this division would drive future value growth. During the quarter, the company continued to demonstrate its pricing power. The company repurchased 5.3 million shares, an annualized rate of 7%, and authorized an additional 15 million shares.

Another large contributor for the quarter was Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) which rose 9%. YTD the company advanced 17%. The company’s myriad of businesses performed well. In insurance, GEICO grew premiums 11% and wrote at a 92% combined ratio. Reinsurance was helped by few natural disaster claims. In rail, Burlington Northern’s revenues rose 8% as volumes increased and pricing improved, particularly in agricultural products following a record grain harvest and limited supply given increased oil shipments. Berkshire’s U.S. and U.K. utility revenues also grew. The manufacturing, service, and retailing businesses increased revenues and earnings. Overall, corporate revenues from these diverse businesses grew 6%, earnings increased 17%, and our appraisal increased.

Longleaf: Level 3 Communications, Bank of New York Mellon  gain 4%

Fiber and networking company Level 3 Communications, Inc. (NYSE:LVLT)’ 4% gain in the quarter took YTD return to 38%. Level 3 had a strong quarter with EBITDA (earnings before interest, taxes, depreciation and amortization) up over 20%, organic revenues up 7%, and positive free cash flow. The company’s purchase of tw telecom, announced in the second quarter, remains on track to close around year-end.

The Bank of New York Mellon Corporation (NYSE:BK) gained 4% in the quarter and 12% YTD. Expense controls helped results, although low market volatility and low rates this year have hampered revenue growth in asset services. The asset management business grew steadily along with the markets. The company emphasized the substantial earnings power that modest interest rate increases will create as money market fee waivers will end and net interest margins will expand. During the quarter BK repurchased almost 1% of outstanding shares, approximately one-third of the total buyback approved by the Federal Reserve.

Although Cheung Kong Holdings Ltd (HKG:0001) declined 7% in the third quarter, its 13% YTD return made this Hong Kong based conglomerate a large contributor for the year. In the first half, Hong Kong property sales were strong, and management made several value-enhancing asset sales across multiple business lines as well as returned capital to shareholders. More recently, Cheung Kong’s price was penalized amid protests and labor strikes in Hong Kong. Our appraisal remained intact. We are partnered with strong capital allocators who have not bought overpriced assets in China or Hong Kong. Cheung Kong’s strong balance sheet positions management to buy discounted land in the event of a real estate correction.

The performance bright spots were overshadowed by the negative impact of the energy sector which fell 9.1% in the S&P 500 Index as oil, gas and coal prices declined between 7-13%. Our appraisals of our three energy-related holdings did not fall in spite of large stock declines, because our models already incorporated lower commodity prices based on the futures curve pricing and the marginal cost of production in our various plays. Chesapeake Energy Corporation (NYSE:CHK) fell 20% in the quarter. While costs declined, capex remained on plan, and the company moved production estimates up slightly.


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