Polen Capital Management, LLC, an independently-owned global investment manager, recently published its first-quarter focus growth commentary – a copy of which can be downloaded here. During the first quarter of 2020, the Polen Focus Growth Composite Portfolio returned -13.03% gross of fees, while the Russell 1000 Growth and S&P 500 indices were down 14.10% and 19.60%, respectively.
In the said letter, Polen Capital spoke about Autodesk Inc. (NASDAQ:ADSK) and O'Reilly Automotive Inc (NASDAQ:ORLY) stocks. Autodesk engages in the design of software and services. O'Reilly Automotive is an auto parts retailer that offers automotive aftermarket parts, tools, supplies, equipment, and accessories. Here is what Polen Capital said:
"In almost any other environment, we would view O’Reilly Automotive as a very stable, safety-like business with solid earnings growth. We consider O’Reilly to be more like healthcare for cars than a retailer. Unfortunately, this pandemic has changed a crucial part of our investment case. Given the stability in the underlying demand for replacement car parts, the company has been managed with a leaner balance sheet, and most of the company’s free cash flow has been used for share repurchases. It is unlikely that O’Reilly’s profits will be impacted enough to cause issues with its debt covenants, but the leverage on O’Reilly’s balance sheet, combined with a much larger impact on the business during a downturn than we could have anticipated, changed our investment case.
To elaborate, the COVID-19 crisis has resulted in significant restrictions on the movement of the U.S. population, and we expect that the number of miles driven will be down significantly for at least some period of time. As people are driving less, fewer will need to visit O’Reilly’s stores to repair their cars. Almost all O’Reilly stores remain open, which also means most in-store expenses will remain while instore revenue will decline. Also, mechanics supplied with O’Reilly parts will likely be impacted as people drive less and look to defer carrelated repairs to both save money and shelter-in-place.
Finally, O’Reilly will likely halt or sharply reduce share buybacks in order to pay down debt. While this is prudent from a financial sustainability perspective, share buybacks are a key component of the earnings per share growth we expect from the business. Even before COVID-19, we anticipated O’Reilly’s revenue and operating profit growth would slow over time, given the maturity of their store base and the business’s already high margins. The unique nature of this crisis, where people are forced to stay inside and drive far less than we could have imagined, is one of the only scenarios in which O’Reilly no longer fits the role of a stable “safety” in our Portfolio and puts the company’s balance sheet in a weaker position than we would like.
We purchased a new 2.5% position in Autodesk. We owned Autodesk from 2005 to 2008 when the company dominated the computeraided design (CAD) software market. Architects, engineers, product designers, and many others use Autodesk’s software to visualize a product or building digitally prior to production. Over the last decade, Autodesk has become the global leader in providing software to three primary markets: 1) architecture, engineering & construction (AEC), 2) manufacturing, and 3) media & entertainment. The business has improved in many ways, including shifting to a subscription-based business model (revenues are now 95% recurring) and continued progress in the digitization of the construction market.
Particularly within AEC, Autodesk’s software is mission-critical and is only becoming a more essential component of the construction process. The construction industry has been slow to adopt digital design and management tools, resulting in significant waste. Today, many building projects are mandating the use of building information modeling (BIM) software to improve efficiencies, and we expect that Autodesk can capitalize on this long-term secular tailwind.
Autodesk has almost no net debt, 30%+ free cash flow margins, returns on capital north of 50%, and revenue growth typically well above 20%. While COVID-19 will affect the business until the economy eventually rebounds, we expect Autodesk to be far more stable than it was during Financial Crisis, to be much less cyclical than its primary commercial real estate end market, and to emerge from this crisis with exceptional growth prospects for many years."
In Q4 2019, the number of bullish hedge fund positions on ADSK stock increased by about 33% from the previous quarter (see the chart here).
In Q4 2019, the number of bullish hedge fund positions on ORLY stock increased by about 36% from the previous quarter (see the chart here).
Do you think it was appropriate to sell ORLY stock?
Disclosure: None. This article is originally published at Insider Monkey.