Longleaf Partners 2nd-Qua Fund – GuruFocus.com

Longleaf Partners Fund fell 15.56% in the second quarter, just ahead of the S&P 500, which fell 16.10%. In another volatile quarter, we saw value continue its relative outperformance versus growth. Although the Partners Fund held up better than the S&P 500, the Fund lagged the Russell 1000 Value. We have seen a bifurcation of value investing approaches – investors “paying for quality” on one end of the spectrum and, on the other extreme, what we would call a “value ETF” which pays low multiples regardless of quality. The former has worked very well over the past decade, and we’ve missed opportunities by not lowering our discount rates or “paying up” in the past, but it’s been a sore place since the beginning of the 2022. The Fund’s relative performance has benefited from limited exposure to growth information technology – although we are finding some interesting new opportunities in growth darlings this year. This latter approach has resulted in the stock’s relative outperformance this year, led by energy companies, big pharma and consumer packaged goods (CPGs) – great places to be in the short term, as Commodity prices rallied, the Federal Reserve raised interest rates and anything with perceived stability held on tight. We consider this to be the first wave of a value bounce, the simplest, statistically cheapest and least volatile outperforming first. However, we wonder if big pharma and integrated oil companies can sustain relative outperformance over the longer term. We believe the second wave of longer-term outperformance will come from our value investing style, which falls somewhere between these two extremes. We remain focused on the quality of business and people, but also recognize that price matters, especially in an environment like today’s. We find opportunities (although we have so far proven to be ahead) in high quality companies with favorable industry dynamics that have innate complexity and/or are poorly understood in the short term.

We encourage you to view our video with portfolio managers Ross Glotzbach and Staley Cates for a more detailed review of the quarter.

Contribution to the return

  • Guillaume (WMB, Financial)- US pipeline operator Williams contributed as it benefited from favorable natural gas tailwinds during the quarter. After reducing the position in the first quarter, we sold the remaining position during the quarter as its price reached our appraised value. It was a very successful investment that was extremely upsetting in 2019 and has now become much more popular with the consensus.
  • Warner Bros. Discovery (WBD, Financial) – A new purchase in the past year, media conglomerate Warner Bros. Discovery’s (WBD, Financial) the stock price was significantly impacted by a terrible Netflix quarter (which is likely a good sign for WBD in the long run) and fears of a downturn affecting ad revenue and subscribers. While we believe these concerns are valid, media has always been an attractive sector for our investment style and media companies have been the beneficiaries of inflation. As the market takes a “show me” approach to see how the merger will play out, we believe the company has several levers to increase free cash flow per share. We saw eight different insiders personally buy shares during the quarter, which is an extremely strong vote of confidence from people who have a clear view of the challenges and opportunities facing the company.
  • MGM Resorts (MGM, Financial) – The online casino and gaming company declined during the quarter as potential travel cuts amid rising fuel prices and recession fears weighed on the stock. Additionally, the wider online gambling industry has fallen out of favor, but BetMGM’s online gambling business continues to grow regardless of the environment. In a strong vote of confidence, MGM and IAC together bought $405 million worth of MGM stock from (still significant) shareholder Corvex Management in February, and insiders have added significantly this year. The company is also one of our major share repurchasers.
  • General Electric (GE, Financial) – Aviation, healthcare and energy conglomerate GE was punished in the quarter on top-down economic fears for this seemingly cyclical set of businesses. However, the market is not giving the company credit for the hardware improvements CEO Larry Culp has made during his tenure. The balance sheet is stronger today than it has been in a very long time, and each of the three major business segments each have strong avenues for increasing earnings, regardless of the economic environment. Health has never been a cyclical activity. Although aviation generally has some economic sensitivity, the business is still benefiting from a strong COVID rebound which is expected to continue even in an uncertain environment. Electricity is a less cyclical business and GE maintains a stable business serving approximately one-third of the world’s electricity. GE is another example of significant insider buying indicating management’s confidence in the company, while the company has also started to buy back discounted shares. GE is still on track to divide the business into three distinct businesses, and we believe this will help the market properly weigh the value of each major segment.

Portfolio activity

We took advantage of the market volatility this year to buy three new companies that were let down by the market for very different reasons. As mentioned above, we see opportunities in fallen growth favorites (although there are plenty of 300-cent dollars that are now closer to 100-cent dollars!), including a “recycling” business which we have successfully owned for the past decade and, in hindsight, sold too soon. We now have the opportunity to invest in this great company which has fallen back into our discount price range. We also see opportunities in the building products world which has been impacted by rising mortgage rates. We bought a great company in this category that we have admired for a long time. Finally, we launched a new position that has been described internally as “the most valuable company” in consumer discretionary that has fallen out of favor, but has a proven management team with whom we have already collaborated. We funded these opportunities by exiting three holdings, including Williams which reached our appraised value after appreciating 97%. We also exited our smaller positions in the CNH spin-off of Iveco and Biogen as we were able to move into better opportunities with a higher margin of safety.

Outlook

The Partners fund is fully invested with 3% cash, and our list on deck is growing amid market volatility. New investments have a high hurdle to qualify given our conviction in our current holdings and the steep portfolio discount, which trades at a rare and attractive price-to-value (P/V) ratio in the lower 50%. We expect to see continued progress in our individual holdings, as our management partners look for catalysts that could generate significant near-term gains. We own companies that have pricing power, strong balance sheets and clear paths to organic growth, and are associated with aligned management teams that proactively take steps to add value in ways that control and close the (almost historically wide) value gap. We believe that our most significant macroeconomic headwinds of the past decade may soon become headwinds.

Returns reflect capital gains and reinvested dividends, but not the deduction of taxes an investor would pay on distributions or stock redemptions. Performance quoted represents past performance. Past performance does not guarantee future results. Investment returns and the principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. The current performance of the fund may be lower or higher than the performance indicated. Performance data up to date to the end of the most recent month can be obtained by visiting southeasternasset.com. The prospectus expense ratio before waiver is 1.00%. Southeastern is contractually committed to limiting its operating expenses (excluding interest, taxes, brokerage and exceptional charges) to 0.79% of average net assets per year. This agreement is effective until at least April 30, 2023 and may not be terminated prior to that date without Board approval.

Before investing in a Longleaf Partners Fund, you should carefully consider the Fund’s investment objectives, risks, charges and expenses. For an up-to-date Prospectus and Simplified Prospectus, which contains this and other important information, please visit https://southeasternasset.com/account-resources. Please read the Prospectus and SummaryProspect carefully before investing.

As of June 30, 2022, the top ten holdings of the Longleaf Partners Fund: Lumen, 11.7%; FedEx, 7.2%; Mattel, 6.7%; Liberty Broadband, 5.4%; IAC, 5.3%; General Electric, 5.1%; Fairfax Financial, 5%; Affiliated Executives Group, 5%; CK Hutchison, 4.9% and Warner Bros Discovery, 4.7%. Fund holdings are subject to change and discussions of holdings do not constitute recommendations to buy or sell securities. Current and future holdings are subject to risk.

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