To Our Shareholders,
For the quarter ended June 30, 2019, the net asset value (NYSE:NAV) per Class A Share of The Gabelli Value 25 Fund increased 4.1% compared with increases of 4.3% and 3.2% for the Standard & Poor's (S&P) 500 Index and the Dow Jones Industrial Average, respectively. Other classes of shares are available. See page 2 for additional performance information for all classes.
An Economic Rorschach Test
Swiss psychologist Hermann Rorschach created his eponymous ink-blot exam in 1921. In the classical test, an administrator records the responses to ten abstract images, hoping to illuminate the subject's motivations, inner conflicts, and modes of perception. The current political climate has certainly served as its own ink-blot test, with the President trumpeting an economy "better than it has been in decades" and those opposed highlighting stagnant wages and growing inequality.
We, of course, attempt to array and interpret macro and micro economic data in as objective a manner as possible, but that makes conclusions about the direction of the economy no less confounding. On one hand, July 2019 marked the 121st month of consecutive growth in the U.S. - the longest expansion on record. At 3.7%, unemployment is the lowest since the 1960s, household wealth is at a record, and housing growth remains solid, all while inflation remains tame. On the other hand, indicators of global manufacturing health are rolling over, international regions including China are slowing markedly, and the yield curve is partially inverted (i.e., the yield on 3-month U.S. Treasury Bill currently exceeds that on the 10-year Treasury note) which historically has preceded recessions (again, dependent on your frame of reference). Trade disputes with Europe, China, and Mexico have weighed on corporate confidence and on earnings for importers, who cannot fully pass along increased costs, and exporters, who find their products disadvantaged by retaliatory tariffs.
As of this writing, a deal with China appears back on track. However, the President is nothing if not unpredictable. Equally compelling cases may be made for the President striking a deal to declare victory and maintain economic momentum into the 2020 election, or not striking a deal to run on the same issue. Likewise, the Chinese could either seek a quick resolution to maintain economic stability or take their chances with a future Democratic administration. Federal Reserve Chairman Jerome Powell apparently shares an uncertain view of these ink-blots, and has thus signaled the U.S. central bank will provide an "insurance cut" to interest rates in July, with more to follow late this year despite a robust economy. Monetary history would suggest that easing will extend the expansion (the stock market thinks so), but what if the Fed's fears are well-founded? Or worse, what if the President parlays this financial flexibility into a policy mistake? Although the odds of catastrophe appear small at this time, unfortunately the potential for a future Fed rescue are diminished with starting rates so low.
The Markets: A View on Value
The major U.S. stock market indices posted their strongest first half gains since 1997 as strength in April and June offset a sharp decline in May. The market rebound since late 2018 can be attributed to excessive economic pessimism triggering the "Trump put" (continued trade talks) and the "Powell put" (the signal of lower interest rates). Each of these elements have supported rising multiples in the face of what is likely to be weak earnings growth for the remainder of this year. After briefly compressing late in 2018, the market is again selling at about 17 times earnings, higher than average but not alarmingly stretched, given tame inflation and low interest rates.
Value investing can be its own psychological test, not just because many followers of Graham & Dodd have had their mental well-being challenged in a decade-old momentum market, but because perceptions of what makes a cheap stock can vary. Popular distinctions between growth and value, made using absolute measures of price-to-earnings or price-to-book, are inadequate. Unlike momentum or technical investors, growth and value investors tend to be rooted in fundamentals. In general, value investors seek to buy assets at a discount to their worth today, while growth investors seek assets that will appreciate meaningfully in worth. Growth can be a component of value, an attribute that may itself be priced cheaply or dearly. Some stocks may appear conventionally expensive but in actuality offer bargains when adjusting for the quality of their franchises or the high return on investment opportunities available to them. When evaluating a security, we rely on our accumulated compounded knowledge of select industries to filter noise and divine hidden assets and sources of growth. If we can acquire shares in those businesses at a large enough discount to what an informed buyer would pay to own the entirety of the business (Private Market Value), we may be interested. Despite a clouded outlook, we see a lot of intriguing situations today.
During the first half of 2019, global deal volume declined 12% to $2 trillion, but volume in the U.S. grew 19% to over $1 trillion. Large transactions in healthcare, energy, and technology led the way. We believe merger and acquisition (M&A) could earn a second wind in the second half of 2019, underpinned by lower rates and a desire to close deals before a possible change of administrations in 2021. The Fund is poised to capitalize in industries undergoing consolidation.
The largest contributor to returns in the second quarter was Sony Corp. (5.4%) (+22%). Fears about how traditional video game console providers would fare in the world of cloud gaming were outweighed by strong music industry performance and a growing addressable market for Sony's image sensors. In addition, activist shareholder Third Point returned with ideas for how the company can surface additional value. Resilient consumer spending helped Mastercard (1.7%) (+11%) and American Express (4.3%) (+11%). The Walt Disney Co. (1.8%) (+24%), purchaser of Twenty-First Century Fox's entertainment business, unveiled a compelling direct-to-consumer video offering to go with a strong film and park attraction slate. Finally, as discussed above, DISH Network (+16%) appears to possess a strong bargaining hand in negotiations with T-Mobile and Sprint as well as appreciation asset value in its spectrum.
Swedish Match (3.9%) (-15%) was the largest detractor from performance in the quarter, giving back most of its first quarter gains due to concerns about pending restrictions on sales of flavored cigars. Other consumer staples holdings Edgewell Personal Care (0.3%) (-39%) and Energizer (0.5%) (-19%) also detracted from performance as certain legacy brands struggled to grow in mature markets, along with concerns about increased financial leverage from acquisitions. Bank of New York Mellon (2.8%) declined as lower interest rates would reduce the interest income it generates. Finally, Mexican broadcaster and cable operator Grupo Televisa (0.7%) (-25%) dropped amidst concerns about the health of the Mexican economy and after the company delayed a potential spin-off of its cable business.
Let's Talk Stocks
The following are stock specifics on selected holdings of our 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 share prices are listed first in United States dollars (USD) and second in the local currency, where applicable, and are presented as of June 30, 2019.
American Express Co. (NYSE:AXP) (4.3% of net assets as of June 30, 2019) (AXP - $123.44 - NYSE) is the largest closed loop credit card company in the world. The company operates its eponymous premiere branded payment network and lends to its largely affluent customer base. As of December 2018, American Express has 114 million cards in force and nearly $82 billion in loans, while its customers charged approximately $1.2 trillion of spending on their cards in 2018. The company's strong consumer brand has allowed American Express to enter the deposit gathering market as an alternate source of funding, while the company's affluent customers have picked up spending. Longer term, American Express should capitalize on its higher spending customer base and continue to expand into other payment related businesses, such as corporate purchasing, while also growing in emerging markets. Similarly, the company is looking at the growing success of social media as an opportunity to expand its product base and payment options.
Bank of New York Mellon Corp. (NYSE:BK) (2.8%) (BK - $44.15 - NYSE) is a global leader in providing financial services to institutions and individuals. The company operates in more than one hundred markets worldwide and strives to be the global provider of choice for investment management and investment services. As of December 2018, the firm had $33.1 trillion in assets under custody and $1.7 trillion in assets under management. Going forward, we expect BK to benefit from rising global incomes and the cross border movement of financial transactions. We believe BK is also well positioned to grow earnings in a rising interest rate environment, given its large customer cash deposits and significant loan book
Crane Co., (NYSE:CR) (2.1%) (CR - $83.44 - NYSE) based in Stamford, Connecticut, is a diversified manufacturer of highly engineered industrial products comprised of four business segments: Fluid handling, Aerospace & Electronics, Engineered Materials, and Payments & Merchandising Systems with over 11,000 employees across 26 countries. The company recently acquired Crane Currency, a producer of currency products for more than 200 years and is entrusted by more than 50 central banks to play an integral role in the design and manufacture of their nations' banknotes. Crane Currency is the fastest growing fully integrated global currency provider and is an excellent complement to Crane Co.'s expanding presence in the currency and payment markets. On May 21, Crane made an offer to acquire CIRCOR (1.1%) for $45 per share or $896 million. On June 17, 2019, Crane commenced a tender offer for all outstanding shares of CIRCOR. On July 8, Crane increased its offer to $48 per share.
DISH Network Corp. (NASDAQ:DISH) (1.4%) (DISH - $38.41 - NASDAQ) is the fourth largest pay television provider in the U.S., serving approximately 14 million subscribers through its original satellite business and newer Sling internet delivered over-the-top offering. Founder Charlie Ergen owns approximately half of DISH's shares. DISH has accumulated a significant spectrum position at attractive prices. DISH could monetize its spectrum through a sale of the spectrum or the whole company, or, more likely, a partnership with an existing wireless operator or new entrant to the industry such as Amazon. These events could be accelerated if, as reported, DISH facilitates the merger of Sprint and T-Mobile by establishing a wireless business using a portion of the combined company's customers and network capacity.
Honeywell International Inc. (NYSE:HON) (2.3%) (HON - $174.59 - NYSE) operates as a diversified technology company with highly engineered products, including turbine propulsion engines, auxiliary power units, aircraft brake pads, environmental control systems, engine controls, communications and navigation systems, sensors, building automation, catalysts and absorbents and process technology for the petrochemical and refining industries, and warehouse automation equipment and software. One of the key drivers of HON's growth is acquisitions that increase the company's growth profile globally, creating both organic and inorganic opportunities.
H&R Block (NYSE:HRB) (0.7%) (HRB - $29.30 - NYSE) is the largest assisted tax preparation business in the U.S., conducting operations through company owned and franchised locations. The company is also a leading provider of "do-it-yourself" (DIY) tax preparation software and has begun offering customers a variety of hybrid DIY/assisted options. The company has been improving service and investing in digital to meet the slow but steadily increasing customer preference for DIY, steps that were accelerated when Jeffrey Jones became CEO in 2017. As part of this transformation, in June 2019 H&R Block purchased Wave Financial, a fast-growing, cloud-based bookkeeping service for small businesses. H&R Block should be able to accelerate its topline while integrating Wave and cross-selling tax services to an underpenetrated market. In the meantime, the company should be able to improve tax prep market share and margins while continuing to generate significant cash flow for shareholders.
Navistar International Corp. (NYSE:NAV) (1.2%) (NAV - $34.45 - NYSE) based in Lisle, Illinois, manufactures Class 4-8 trucks, buses, and defense vehicles, as well as diesel engines and parts for the commercial trucking industry. NFC, a wholly-owned subsidiary, provides financing of products sold by the company's truck segment. Navistar has continued to see its operations and market share improve following a September 2016 $256 million (16.6% stake) investment by Volkswagen. More recently, Volkswagen provided more information on its intention to separate its Truck & Bus division, which owns the VW brand as well as MAN and Scania in Europe. This separation we believe, increases the likelihood that VW Truck & Bus will seek to buy Navistar outright in the future.
Newmont Mining Corp. (NYSE:NEM) (3.9%) (NEM - $38.47 - NYSE) based in Denver, Colorado, is one of the largest gold mining companies in the world. Founded in 1921 and publicly traded since 1925, NEM is the only gold company included in the S&P 500 Index and Fortune 500. We expect the company to produce approximately 5.2 million ounces of gold and 120 million pounds of copper in 2018, with approximately 70% of this production coming from the United States and Australia. Newmont undertook company wide cost cutting measures during the period 2013 - 2017, lowering its average unit costs base by over 20% during this period. The company has sold non-core assets and has deployed the proceeds from these sales into repaying debt and building new projects which it expects will generate superior rates of return for shareholders. Given Newmont's largely fixed cost base, every increase (or decrease) in the gold price will flow directly to the company's bottom line.
Sony Corp. (NYSE:SNE) (5.4%) (SNE - $52.39 - NYSE) is a diversified electronics and entertainment company based in Tokyo, Japan. The company manufactures image sensors, PlayStation videogame consoles, mobile devices, consumer electronics, and mirrorless and professional cameras. It also operates the Columbia film studio and Sony Music entertainment group and hold majority ownership of Sony Financial Services. We expect growth opportunity in image sensor and game business and operational improvements in consumer electronics and entertainment to generate EBITDA growth through 2020.
Viacom Inc. (NASDAQ:VIA) (5.8%) (VIA - $34.10 - NASDAQ) is a pure-play content company that owns a global stable of cable networks, including MTV, Nickelodeon, Comedy Central, VH1, BET, and the Paramount movie studio. Viacom's cable networks generate revenue from advertising sales, fixed monthly subscriber fees, and ancillary revenue from toy licensing. We believe a low valuation and M&A potential outweigh the secular risks of cord-cutting.
At this writing, U.S. markets may be hitting record highs, but they barely exceed their place nine months ago. Sell-offs in late 2018 and in May are reminders that volatility can be violent and can return unexpectedly, especially as the interest rate regime turns, the next elections approach, and the cycle ages. The market can be perplexing, but we will continue to try to make sense of the blots, dots, or whatever data we can obtain to aid in the picking of stocks that we believe will deliver superior risk-adjusted returns over the long run.
August 2, 2019
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.
This article first appeared on GuruFocus.
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