David Rolfe

David Rolfe

Last Update: 02-14-2017

Number of Stocks: 36
Number of New Stocks: 2

Total Value: $4,096 Mil
Q/Q Turnover: 6%

Countries: USA
Details: Top Buys | Top Sales | Top Holdings  Embed:

David Rolfe Watch

  • David Rolfe Invests in Tractor Supply, Fastenal

    Wedgewood Partners’ David Rolfe (Trades, Portfolio) gained two new holdings and divested another in the final quarter of 2016. He established positions in Tractor Supply Co. (NASDAQ:TSCO) and Fastenal Co. (NASDAQ:FAST). He sold out of Stericycle Inc. (NASDAQ:SRCL).


    With over 29 years of portfolio management experience, Rolfe serves as the chief investment officer at Wedgewood. The firm believes significant long-term wealth is created by investing as “owners” in a company. Wedgewood seeks highly profitable companies that offer a dominant product or service, consistently grow earnings, revenues and dividends and have strong management teams that prioritize shareholders. The current portfolio is composed of 36 stocks and is valued at around $4.1 million.

      


  • If Only Ross' Shares Were as Discounted as Its Merchandise

    Ross Stores Inc. (NASDAQ:ROST) is a growth story in retail despite no online presence. The company uses buying and merchandising expertise to sell name-brand and designer goods for up to 70% less than conventional retailers.


    It has more than 1,500 stores selling personal and home fashion through Ross Dress for Less and dd’s Discount. In coming years, it expects to grow the chains to at least 2,500 stores.

      


  • David Rolfe Comments on Visa

    Visa (NYSE:V)'s valuation came under pressure following the election early November as the market saw a rotation out of higher-multiple tech and financial securities and into more cyclical names. We used this opportunity to increase weightings across accounts as valuation levels became more attractive.


    Visa has consistently grown its revenue, EBITDA, and earnings double digits as it has played a key role in facilitating commerce’s multi-decade move away from paper-based transactions. The Company effectively represents the collective economic bargaining power of many of the United States’ and, more recently Europe’s, credit and debit card issuers – particularly banks. Visa has tremendous scale in card transaction processing, as they facilitated over $5.7 trillion in credit and debit volume across more than 120 billion transactions, during their fiscal 2016 - well above 2015 levels. Going forward, we fully expect to see this growth trajectory continue, with added help from the integration of Visa Europe which, as we've discussed previously, should help drive double digit accretion.

      


  • David Rolfe Comments on Tractor Supply Company

    Like Fastenal, Tractor Supply Company (NASDAQ:TSCO) is a company we have long admired. Management has executed a disciplined retailing strategy where they have carved out a niche, serving rural land owners with higher than average incomes. The Company has very deliberately positioned itself to be distinct from its competitors, namely Home Depot, Lowe’s, and, to a lesser extent, Wal-Mart, primarily by locating itself in more rural locations and focusing on merchandise that caters to the maintenance needs of a rural lifestyle, in a one-stop shop format (i.e. all-terrain vehicle replacement parts and feed for livestock as pets).


    We think the Company's profitability and value proposition will be insulated over time as they have made key tradeoffs to avoid competing with big box retailers, without necessarily impairing returns. As an example, we found evidence that the company’s real estate strategy, on average, has been to simultaneously locate Tractor Supply Company stores further from “big box” competitors, while getting into more densely populated markets. Meanwhile, the Company has managed to lower the build-out and rental costs of their new stores as they have continued to expand the store base aggressively, leading to improved returns - something that is particularly difficult in the brick-and-mortar retail world, where typically new store openings generate a lower level of sales and profitability than mature stores (naturally pressuring return on investment as the company grows). We assume the Company’s continuing store base expansion, as well as a conservative assumption on same store sales, should enable the Company to grow revenues in the mid-to-high single digits over the next several years, with earnings per share growth in the double digits, driven by a combination of flat to modest margin expansion as well as stock buybacks.

      


  • David Rolfe Comments on TreeHouse Foods

    TreeHouse Foods (NYSE:THS) was a relative detractor from performance during the quarter after a confluence of a few unfortunate, though we think transient, events. The Company unexpectedly missed its quarterly earnings estimates and reduced 2016 guidance, despite having had a few wins earlier in the year not long after closing the Private Brands acquisition in January. The Company reiterated, however, its long-term accretion guidance for Private Brands. From the time the merger was announced (late 2015), we had seen multiple areas where we think this longer-term guidance is still understated. Because of our belief in this cushion management built into their original guidance, we remain comfortable that they will be able to hit their long-term growth expectations, despite these shorter-term issues.


    On the same day the Company announced its disappointing Q3, the company also announced that their COO, Chris Sliva, was leaving the company. He turned up as the new CEO of a small food company a few days later. Fortunately - the only bit of good news on the day - Dennis Riordan, the retiring CFO, reversed his retirement on this news, announcing that he would stay on as President/COO for as long as he was needed.

      


  • David Rolfe Comments on Stericycle

    We liquidated Stericycle (NASDAQ:SRCL) from portfolios after we determined that the Company's competitive advantage in its core regulated medical waste (RMW) business was not as robust as we had seen during the past five years of our holding period. Prior to the erosion in the economics of their core RMW business, we remained optimistic about Stericycle’s business. Despite recent stumbles in their non-core hazardous waste business and slower than expected integration of newly acquired Shred-it, the RMW business continued to serve as the engine to double-digit growth in free cash flow. We previously believed that Stericycle's unrivaled scale had served to insulate its RMW profitability from competitive pressures, including customer push-back associated with consolidating end-markets, as many of Stericycle’s most profitable customers - particularly individual physician practices


    • have been consolidated by managed care organizations over the past several years. However, over the past few quarters, management began disclosing that the long-term contracts associated with these newly consolidated customers were coming up for renewal at significantly lower prices. It is not clear to us why the Company gave up this pricing, given that the market has few large-scale alternatives to Stericycle. Suffice it to say, these contracts are in place for several years (sometimes five years or more), and while the Company can spend this time recovering economics through more cross selling, this strategy is unproven and potentially dilutive. As such we lost conviction in Stericycle’s ability to defend its excess profitability in RMW, and subsequently liquidated our positions.
    •   


  • David Rolfe Comments on Charles Schwab

    Charles Schwab (NYSE:SCHW) was a top performer in the quarter as the company stands to benefit from the continued normalization of U.S. monetary policy. Despite a single federal funds rate hike during calendar year 2016, market expectations for further rate hikes have dramatically risen in the face of potential fiscal stimulus and higher inflation expectations.


    While we understand the market’s desire to discount the near-term “embedded option” of money market fee waiver relief at Schwab, we continue to invest in the Company for its industry-leading pretax profit margins and asset gathering capabilities, which we think are a byproduct of their consistent productivity investments made over the past few decades. We think this positions Schwab well in the increasingly commodified financial services industry, as the Company’s low-cost model and scale allows them to pass savings on to advisors and clients in the form of competitively lower fees, in exchange for mid-single digit platform asset growth. Combined with modest rate relief and continued productivity gains, we expect Schwab to continue posting earnings per share growth in the mid-teens.

      


  • David Rolfe Comments on Fastenal

    Fastenal (NASDAQ:FAST) is a company we have followed and admired for many years. The Company is a distributor of manufacturing and construction supplies - generally consumable parts and products such as fasteners (i.e., screws, nuts/bolts) and various items used in the maintenance, repair, and operations (MRO) of customers’ plants. The company has established a differentiated position in its industry by investing heavily to get itself as close as possible to a generally smaller, less urban customer base than its competitors. This is most evident in its extensive network of more than 2,500 branch locations, which the company effectively uses as selling and distribution outposts to serve its customer base. We contrast this with Fastenal’s largest competitor, Grainger, for example, which has only 300-odd branch locations (and shrinking) despite having twice the revenues as Fastenal. We believe this has led to a fairly healthy segmentation between the Company and its competitors: Fastenal has specialized in smaller, geographically dispersed clients who are more heavily reliant on the Company’s local distribution capabilities, sales expertise, and somewhat more specialized, locally tailored product lines; Grainger and other competitors specialize in larger, more urban clients who have more distribution and service requirements, so these distributors generally focus on more standardized products, in large quantities at the lowest cost. When we observe the healthy, and remarkably steady, returns on investment across the major competitors in the space, we view this as confirmation that the major players, for the most part, have managed to carve out profitable segments of an attractive industry without tripping over each other.


    Fastenal has extended its differentiation in recent years through three other initiatives designed to get closer to its customers. First, the Company has installed over 60,000 vending machines in customers’ plants, in which they constantly replenish products customers use regularly in their manufacturing processes. Second, the Company has accelerated the expansion of its Onsite program, in which it basically opens a small Fastenal store within a larger customer’s plant. Fastenal staffs and stocks this mini-location, effectively taking control of a portion of the customer’s supply chain. It is important to note that both the Vending and (especially) Onsite initiatives further integrate the Company into a customer’s operations, helping to make these customers stickier. Third, Fastenal has invested in additional inventories over the past several quarters, while also shifting a higher percentage of its inventory from its distribution centers into its branch locations. This once again is designed to get Fastenal as close to its customers as possible - if the Company has the products its customers need, already waiting in their market, available for same-day delivery, at an attractive price, there is no need for those customers to take their business elsewhere, whether that be to a larger, out-of-market competitor such as Grainger or to an online competitor such as Amazon.

      


  • David Rolfe Comments on Berkshire Hathaway

    Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) continues to carry an outsized weighting in portfolios – in fact, the stock continues to be one of our largest holdings. We believe the Company maintains a long-term competitive advantage, evidenced in its below-average cost of capital, which should become more valuable in an environment of both heightened equity market volatility and/or higher cost of borrowing. 2016 operating results were quite impressive given the headwinds in the bull market-laden, over crowded reinsurance business, plus the stagnant growth at Burlington Northern. The stock did enjoy a post -Trump election pop of nearly 15%. Mr. Market's early enthusiasm for Trump's fiscal proposals of lower corporate tax rates, if enacted, would certainly benefit Berkshire's bottom line. The Company could potentially be a huge beneficiary of meaningfully lower corporate tax rates. If enacted, lower corporate tax rates would have an out-sized impact by reducing Berkshire’s deferred tax liability by boosting the Company’s book value. The Company currently has amassed a massive $65 billion deferred tax liability that Buffett himself has equated to an interest-free loan from the U.S. government. If Trump, and the Republican controlled Congress are successful in lowering corporate tax rates to 15% from the current statutory rate of 35%, the Company’s book value could rise double digits. In addition, given the terrific year-end rally in bank and financial stocks, the nice pop in the Company's multibillion-dollar holdings, including American Express, Bank of America, Goldman Sachs, M&T Bank, U.S. Bank, and Wells Fargo. Bank of America and Wells Fargo enjoyed outsized gains during the quarter of 42% and 25%, respectively. Berkshire's bank and financial stock holdings have now reached a cumulative market value of over $57 billion.

    From David Rolfe (Trades, Portfolio)'s fourth quarter 2016 Wedgewood Partners investor letter.   


  • David Rolfe Comments on Kraft Heinz

    Kraft Heinz (NASDAQ:KHC) is a rare example of a company that has issued sizable debt with the goal of increasing sales and earnings - particularly earnings, in the case of Kraft Heinz. The unique, hard-to-copy management style of 3G (entrepreneurial, zero-base budgeting), coupled with low-cost debt, has proven to be quite a powerful combination for driving higher profitability well beyond industry peers.

    From David Rolfe (Trades, Portfolio)'s fourth quarter 2016 Wedgewood Partners investor letter.   


  • David Rolfe Comments on Apple Inc.

    We should note successful examples of the use of outsized debt by our own invested companies. Consider Apple. Apple (NASDAQ:AAPL) generates enough cash ($65 billion in operating cash TTM) that even after spending $10 billion in R&D in fiscal 2016, the Company’s balance sheet liquidity grew almost $10 billion, to over $250 billion. This trove is trapped overseas awaiting a change in U.S. repatriation laws - a potentially significant bullish event for shareholders. In the meantime, in order to return this cash back to shareholders, the Company has issued over $75 billion in debt.


    Further, and often left unremarked by Wall Street’s finest, is the rapid, and accelerating growth in Apple’s R&D spending over the past few years. Clearly the Company does not need to spend $10-$15 billion per year to sustain the evolutionary upgrades to the iPhone, iPad, Apple Watch and/or new video streaming services. Apple’s nascent automotive program Project Titan may not be at all about creating a complete autonomous driving car (Apple Car), but rather the creation of software that makes existing cars smarter – or even autonomous. Now that is a huge, creatively disruptive opportunity.

      


  • David Rolfe's Wedgewood Partners 4th Quarter Letter: Changing of the Guard

    Review and Outlook

      


  • David Rolfe Buys 1, Sells 1 in 3rd Quarter

    Wedgewood Partners’ David Rolfe (Trades, Portfolio) acquired one new holding and sold another in the third quarter.


    Rolfe is the chief investment officer at Wedgewood. The firm’s investment philosophy is established on the belief that significant long-term wealth can be created through investing as an “owner” in a company. It looks for a dominant product or service that is hard to compete with, has sustainable and consistent growth of revenue, earnings and dividends, is highly profitable and has a strong, shareholder-oriented management team.

      


  • Robert Olstein Invests in Waste Management, Outdoor Sports, Lab Products

    Olstein Capital Management’s Robert Olstein (Trades, Portfolio) bought eight new holdings in the third quarter. His top three new holdings are Stericycle Inc. (NASDAQ:SRCL), Vista Outdoor Inc. (NYSE:VSTO) and VWR Corp. (NASDAQ:VWR).


    Olstein founded his firm in 1995. It follows an accounting-driven, value-oriented philosophy that is based on the premise that the price of a common stock may not reflect the company’s true value. The investment team employs analytical and valuation methods to determine the quality of a company. It looks behind the numbers to assess the company’s financial strength and downside risk.

      


  • Apple Reports Strong Fiscal 4th Quarter Earnings

    During the fiscal quarter ended Sept. 25, Apple Inc. (NASDAQ:AAPL) reported $46.9 billion in net income and diluted earnings per share of $1.67. The company’s gross margin slightly declined compared to the corresponding quarter last year.


    While these values were slightly lower compared to the fiscal fourth quarter of 2015, Apple’s service revenue reached an all-quarter high of $6.3 billion in the most recent quarter, likely due to increased iPhone 7 sales and Samsung Electronics Co. Ltd. (XKRX:005930) (XKRX:005935) terminating its Note 7.

      


  • David Rolfe Comments on TreeHouse Foods Inc.

    We initiated positions in TreeHouse Foods, Inc. (NYSE:THS) during the third quarter. TreeHouse is the largest private label food manufacturer and distributor in North America. An aphorism in the private label industry is that “a grocer is only as good as their private label.” As such, private label food has been growing its share of the North American food industry over the past several years, as consumers have sought value in comparison with branded food, and as grocery retailers and other food vendors have pursued the greater profitability to themselves of private label products. This trend primarily began in national-brand equivalents, in which TreeHouse and other private label manufacturers offer products of comparable quality to brand names but at better prices. However, much of TreeHouse’s growth in recent years has come from premium products, which often might be natural/organic/healthy choices and possibly of even greater quality or featuring greater innovation (flavors/recipes) than competing branded products. Having evolved from simply offering retail customers a "good/better/best" option of national brand equivalents, the Company has begun to offer deeper category segmentation and insights, while developing and manufacturing multi-tiered pricing assortments, so their retail customers can better compete under the pricing umbrella typically created by higher priced national brands. Many of TreeHouse’s best customers, including large, growing retailers such as Trader Joe’s, Aldi’s, Amazon, and Kroger, have embraced this more complete portfolio strategy of private label products, which offers the retailers not only improved profitability but also better sales opportunities, as well. In addition, TreeHouse’s scale and presence in over 20 food categories, enhances its value proposition, which is to help grocery customers hone in on this secular trend towards customized store brands.


    The Company has been growing successfully through acquisition since its formation in 2005. TreeHouse has driven value in its acquired businesses by bringing to bear greater operational capabilities and expertise, greater resources behind innovation and customer research, much greater scale and buying power, and an extensive existing customer list into which the acquired businesses could sell. In early 2016, TreeHouse completed the transformational acquisition of the Private Brands business of ConAgra Foods, effectively doubling TreeHouse’s revenue base and operating footprint while removing its only private label competitor of any meaningful size, all at what we view as an attractive purchase price. The acquired business had struggled under the ownership of ConAgra, which historically had been a branded player and which had not understood the different skill set required to operate a private label business. We believe that TreeHouse comprehensively understands these operational issues and already has begun to remedy them. Better execution at the acquired business, which will drive improving revenue growth and margins, combined with significant cost savings opportunities as a result of the combined companies’ greatly enhanced scale, will allow TreeHouse to deliver roughly 70% earnings growth from the time of the acquisition to the completion of its integration in 2018. During this integration, we likely will see smaller tuck-in acquisitions, as the company’s capital structure still allows it to be active in consolidating the industry. We estimate that the company has less than 10% market share in North America, with plenty of room to expand organically and through acquisition, both within its current 20+ product categories and in adjacent and new categories.

      


  • David Rolfe Comments on Cognizant

    Cognizant (NASDAQ:CTSH) also detracted from overall performance during the quarter, due to management’s cautious commentary related to the demand environment in two of their core customer verticals. Management’s caution about IT spend in Cognizant’s BFS (Banking and Financial Services) segment trace back to the prolonged low interest rate environment along with increased uncertainty in the macro environment—particularly attributed to the “Brexit” vote, which was relatively fresh news at the time of management’s comments. We do not think this weakness has materialized in the near-term, at least to the extent that management was implying. In addition, but not necessarily new, Cognizant has four clients in the HMO (health-maintenance organization) industry, all attempting to merge with or acquire the other. Though the extended timeline of these M&A deals likely pushes out the timing of expected work for Cognizant at each of these four clients, we think Cognizant’s longer-term positioning as a key partner at all four HMOs will continue to allow them to capture wallet share, regardless of M&A outcomes. Near-term, we expect investors to remain skittish around the shares, if only because the investor base has been skittish for years, with the NTM P/E multiple of Cognizant typically vacillating 20%-30% per year. Despite these recent headwinds to topline growth, we think Cognizant maintains a long- term runway for generating attractive organic growth, as the company benefits from the secular shift of IT spend towards digital solutions. The Company maintains excellent financial strength, with nearly $8 billion in borrowing capacity before reaching the average net debt to operating income leverage of the S&P 500—close to 25% of the current market cap.

    From David Rolfe (Trades, Portfolio)'s Wedgewood Partners third-quarter 2016 shareholder letter.   


  • David Rolfe Comments on Core Labs

    Core Labs (NYSE:CLB) was the third largest detractor from our relative performance during the third quarter. While “energy” continues to be a four-letter word at this point in the cycle of U.S. growth investing,5 we continue to think that Core Labs’ value proposition is worthy of multi-cycle consideration. We estimate that roughly 85% of the Company’s revenues are generated by providing equipment and services for the upkeep of their customers’ existing carbon producing fields. As such, the majority of the value that Core Labs provides its customers is not directly predicated on the activity of drillings rigs, or even on the short-term price of oil. For instance, the Company’s Reservoir Description business generated over 60% of consolidated revenues during the trailing 12 months. Reservoir Description revenues have declined just -16% from their trailing 12-month peak (set during late 2013 through mid 2014 – when oil traded at twice today’s levels). A significant portion of Core Labs’ revenues are generated outside the United States, so we estimate revenues in Reservoir Description have probably fallen by a high single digit percent, constant currency – despite the E&P industry (Core Labs’ customers) drastically cutting budgets by between - 30% and -75% during that timeframe. Thus, a significant portion of Core Labs’ business is very well insulated from the vagaries of short-term oil price fluctuations. Although the margins of this segment have suffered more than revenues, we expect that margins have bottomed and should rapidly rebound with E&P spending budgets, as Core Labs’ management has prudently balanced costs without sacrificing personnel capacity.

    From David Rolfe (Trades, Portfolio)'s Wedgewood Partners third-quarter 2016 shareholder letter.   


  • David Rolfe Comments on Stericycle

    Stericycle (NASDAQ:SRCL) underperformed during the quarter as headwinds related to their core, regulated medical waste (RMW) segment began to emerge. Prior headwinds to the Company were limited to non-core businesses or are short-term issues that should be remedied over the next few quarters. While the stock has become cheap, historically and relatively, we did not add to positions during the quarter, as we continue to evaluate the extent of the pressure the Company is seeing in its RMW business.

    From David Rolfe (Trades, Portfolio)'s Wedgewood Partners third-quarter 2016 shareholder letter.   


  • David Rolfe Comments on Qualcomm

    Qualcomm (NASDAQ:QCOM) was also a top contributor to performance over the past three months. We saw Qualcomm make meaningful progress on its technology licensing (QTL) front after several quarters of patiently waiting for the Company to capture unpaid royalties in China. Although Qualcomm’s chipset franchise (QCT) usually garners most of the attention for the Company, its high-margin QTL segment actually generates two-thirds to three-quarters of consolidated profitability. So while revenues at Qualcomm grew 4%, operating income grew almost 30%, year-over-year. Although it has taken several quarters to eventually materialize, we think that the “lumpy” nature of QTL revenues does not make Qualcomm’s long-term prospects for monetizing its prolific research and development spend (cumulative $16 billion over the past three years), any less attractive. In our opinion, Qualcomm shares remain underappreciated by the market, trading at just 14X next 12 month earnings. In addition, the Company maintains a fortress-like balance sheet with about $20 billion in net cash. As a valuation thought-experiment, if Qualcomm levered its balance sheet to be at parity with the average S&P 500 company's (excluding financials) net debt-to-operating earnings ratio4, the Company would have close to 35% of its market cap available for redeployment. We continue to expect that the long-term growth of the business will drive the stock higher and help close that gap, but our conviction in the stock is reinforced by the Company’s excellent financial health, which is a byproduct of their superior profitability.

    From David Rolfe (Trades, Portfolio)'s Wedgewood Partners third-quarter 2016 shareholder letter.   


  • David Rolfe Comments on Priceline

    Priceline (NASDAQ:PCLN) was another top contributor to performance during the quarter. Despite its strong performance, in our view, Priceline’s stock has underperformed its corporate fundamentals. Over the past three years, earnings per share are up a cumulative +60%, while the P/E multiple has contracted about 15%, to around 19X the next 12-month earnings. Further, if we assume that all stocks receive some kind of multiple expansion benefits due to currently low interest rates, 3 then Priceline’s multiple contraction looks all the more stark. Thus, although Priceline has executed torrid value creation relative to the benchmark, the stock has posted a fraction of the outperformance. We continue to think Priceline’s competitive advantage consists of scale on both the supply and demand side of the hospitality industry. With over 90% of the Company’s profitability coming from non-US markets, particularly from Europe, we believe their strategy of foregoing low-margin US bookings in favor of bookings in higher-margin, fragmented markets is a sensible one.

      


  • David Rolfe Comments on Apple

    During the quarter, Apple (NASDAQ:AAPL) was a top contributor to relative performance. Apple has been in portfolios for nearly a decade. Even though Apple is one of the most visible and widely followed businesses in our investment universe, we believe it has long suffered from the incorrect market perception that its customer relationships are largely transactional in nature. We see evidence of these "hit-driven" fears embedded in the systematic contraction of Apple's forward price-to-earnings (P/E) multiple. Apple's P/E multiple peaked in the fall of 2007 at about 38X (not long after the iPhone launched and the S&P 500 P/E peaked for that cycle) and has contracted to around 12.7X, albeit up from the 9X and 10x multiples seen earlier this year and in 2013. We earnestly admit that Apple probably does not deserve to trade at the 38X forward earnings2, yet we believe that Apple’s iOS franchise and “annuity-like” ecosystem has demonstrated an exceptional ability to retain and obtain repeat customers, while commanding over 90% of the profitability generated by smartphone manufacturers—qualities we think should help the stock generate extremely attractive returns at the current multiple.

      


  • David Rolfe Comments on TreeHouse Foods

    We initiated positions in TreeHouse Foods, Inc. (NYSE:THS) during the third quarter. TreeHouse is the largest private label food manufacturer and distributor in North America. An aphorism in the private label industry is that “a grocer is only as good as their private label.” As such, private label food has been growing its share of the North American food industry over the past several years, as consumers have sought value in comparison with branded food, and as grocery retailers and other food vendors have pursued the greater profitability to themselves of private label products. This trend primarily began in national-brand equivalents, in which TreeHouse and other private label manufacturers offer products of comparable quality to brand names but at better prices. However, much of TreeHouse’s growth in recent years has come from premium products, which often might be natural/organic/healthy choices and possibly of even greater quality or featuring greater innovation (flavors/recipes) than competing branded products. Having evolved from simply offering retail customers a "good/better/best" option of national brand equivalents, the Company has begun to offer deeper category segmentation and insights, while developing and manufacturing multi-tiered pricing assortments, so their retail customers can better compete under the pricing umbrella typically created by higher priced national brands. Many of TreeHouse’s best customers, including large, growing retailers such as Trader Joe’s, Aldi’s, Amazon, and Kroger, have embraced this more complete portfolio strategy of private label products, which offers the retailers not only improved profitability but also better sales opportunities, as well. In addition, TreeHouse’s scale and presence in over 20 food categories, enhances its value proposition, which is to help grocery customers hone in on this secular trend towards customized store brands.


    The Company has been growing successfully through acquisition since its formation in 2005. TreeHouse has driven value in its acquired businesses by bringing to bear greater operational capabilities and expertise, greater resources behind innovation and customer research, much greater scale and buying power, and an extensive existing customer list into which the acquired businesses could sell. In early 2016, TreeHouse completed the transformational acquisition of the Private Brands business of ConAgra Foods, effectively doubling TreeHouse’s revenue base and operating footprint while removing its only private label competitor of any meaningful size, all at what we view as an attractive purchase price. The acquired business had struggled under the ownership of ConAgra, which historically had been a branded player and which had not understood the different skill set required to operate a private label business. We believe that TreeHouse comprehensively understands these operational issues and already has begun to remedy them. Better execution at the acquired business, which will drive improving revenue growth and margins, combined with significant cost savings opportunities as a result of the combined companies’ greatly enhanced scale, will allow TreeHouse to deliver roughly 70% earnings growth from the time of the acquisition to the completion of its integration in 2018. During this integration, we likely will see smaller tuck-in acquisitions, as the company’s capital structure still allows it to be active in consolidating the industry. We estimate that the company has less than 10% market share in North America, with plenty of room to expand organically and through acquisition, both within its current 20+ product categories and in adjacent and new categories.

      


  • David Rolfe Comments on Cognizant

    Cognizant (NASDAQ:CTSH) also detracted from overall performance during the quarter, due to management’s cautious commentary related to the demand environment in two of their core customer verticals. Management’s caution about IT spend in Cognizant’s BFS (Banking and Financial Services) segment trace back to the prolonged low interest rate environment along with increased uncertainty in the macro environment—particularly attributed to the “Brexit” vote, which was relatively fresh news at the time of management’s comments. We do not think this weakness has materialized in the near-term, at least to the extent that management was implying. In addition, but not necessarily new, Cognizant has four clients in the HMO (health-maintenance organization) industry, all attempting to merge with or acquire the other. Though the extended timeline of these M&A deals likely pushes out the timing of expected work for Cognizant at each of these four clients, we think Cognizant’s longer-term positioning as a key partner at all four HMOs will continue to allow them to capture wallet share, regardless of M&A outcomes. Near-term, we expect investors to remain skittish around the shares, if only because the investor base has been skittish for years, with the NTM P/E multiple of Cognizant typically vacillating 20%-30% per year. Despite these recent headwinds to topline growth, we think Cognizant maintains a long- term runway for generating attractive organic growth, as the company benefits from the secular shift of IT spend towards digital solutions. The Company maintains excellent financial strength, with nearly $8 billion in borrowing capacity before reaching the average net debt to operating income leverage of the S&P 500—close to 25% of the current market cap.


    From Wedgewood Partners' third quarter 2016 shareholder commentary.

      


  • David Rolfe Comments on Core Labs

    Core Labs (NYSE:CLB) was the third largest detractor from our relative performance during the third quarter. While “energy” continues to be a four-letter word at this point in the cycle of U.S. growth investing,5 we continue to think that Core Labs’ value proposition is worthy of multi-cycle consideration. We estimate that roughly 85% of the Company’s revenues are generated by providing equipment and services for the upkeep of their customers’ existing carbon producing fields. As such, the majority of the value that Core Labs provides its customers is not directly predicated on the activity of drillings rigs, or even on the short-term price of oil. For instance, the Company’s Reservoir Description business generated over 60% of consolidated revenues during the trailing 12 months. Reservoir Description revenues have declined just -16% from their trailing 12-month peak (set during late 2013 through mid 2014 – when oil traded at twice today’s levels). A significant portion of Core Labs’ revenues are generated outside the United States, so we estimate revenues in Reservoir Description have probably fallen by a high single digit percent, constant currency – despite the E&P industry (Core Labs’ customers) drastically cutting budgets by between - 30% and -75% during that timeframe. Thus, a significant portion of Core Labs’ business is very well insulated from the vagaries of short-term oil price fluctuations. Although the margins of this segment have suffered more than revenues, we expect that margins have bottomed and should rapidly rebound with E&P spending budgets, as Core Labs’ management has prudently balanced costs without sacrificing personnel capacity.


    From Wedgewood Partners' third quarter 2016 shareholder commentary.

      


  • David Rolfe Comments on Stericycle

    Stericycle (NASDAQ:SRCL) underperformed during the quarter as headwinds related to their core, regulated medical waste (RMW) segment began to emerge. Prior headwinds to the Company were limited to non-core businesses or are short-term issues that should be remedied over the next few quarters. While the stock has become cheap, historically and relatively, we did not add to positions during the quarter, as we continue to evaluate the extent of the pressure the Company is seeing in its RMW business.


    From Wedgewood Partners' third quarter 2016 shareholder commentary.

      


  • David Rolfe Comments on Qualcomm

    Qualcomm (NASDAQ:QCOM) was also a top contributor to performance over the past three months. We saw Qualcomm make meaningful progress on its technology licensing (QTL) front after several quarters of patiently waiting for the Company to capture unpaid royalties in China. Although Qualcomm’s chipset franchise (QCT) usually garners most of the attention for the Company, its high-margin QTL segment actually generates two-thirds to three-quarters of consolidated profitability. So while revenues at Qualcomm grew 4%, operating income grew almost 30%, year-over-year. Although it has taken several quarters to eventually materialize, we think that the “lumpy” nature of QTL revenues does not make Qualcomm’s long-term prospects for monetizing its prolific research and development spend (cumulative $16 billion over the past three years), any less attractive. In our opinion, Qualcomm shares remain underappreciated by the market, trading at just 14X next 12 month earnings. In addition, the Company maintains a fortress-like balance sheet with about $20 billion in net cash. As a valuation thought-experiment, if Qualcomm levered its balance sheet to be at parity with the average S&P 500 company's (excluding financials) net debt-to-operating earnings ratio4, the Company would have close to 35% of its market cap available for redeployment. We continue to expect that the long-term growth of the business will drive the stock higher and help close that gap, but our conviction in the stock is reinforced by the Company’s excellent financial health, which is a byproduct of their superior profitability.


    From Wedgewood Partners' third quarter 2016 shareholder commentary.

      


  • David Rolfe Comments on Priceline

    Priceline (NASDAQ:PCLN) was another top contributor to performance during the quarter. Despite its strong performance, in our view, Priceline’s stock has underperformed its corporate fundamentals. Over the past three years, earnings per share are up a cumulative +60%, while the P/E multiple has contracted about 15%, to around 19X the next 12-month earnings. Further, if we assume that all stocks receive some kind of multiple expansion benefits due to currently low interest rates, 3 then Priceline’s multiple contraction looks all the more stark. Thus, although Priceline has executed torrid value creation relative to the benchmark, the stock has posted a fraction of the outperformance. We continue to think Priceline’s competitive advantage consists of scale on both the supply and demand side of the hospitality industry. With over 90% of the Company’s profitability coming from non-US markets, particularly from Europe, we believe their strategy of foregoing low-margin US bookings in favor of bookings in higher-margin, fragmented markets is a sensible one.


    From Wedgewood Partners' third quarter 2016 shareholder commentary.

      


  • Wedgewood Partners 3rd Quarter Letter: Is Indexation Investing the New Momentum Speculation?

    'Too much of a good thing can be wonderful!'


    Mae West

      


  • New: GuruFocus Podcast Interviews John Buckingham and David Rolfe About Apple Stock

    GuruFocus unveils a new podcast today.


    Episode 1 features two well-known investors, John Buckingham (Trades, Portfolio) of Al Frank Asset Management and David Rolfe (Trades, Portfolio) of Wedgewood Partners. They have a conversation with GuruFocus about the state of iPhone maker Apple and answer some bearish questions. Apple is Rolfe's top holding and Buckingham's fourth largest.

      


  • New GuruFocus Podcast: Interview With John Buckingham and David Rolfe About Apple

    GuruFocus is introducing a new podcast today that will link members even closer to gurus, news, and intelligent discussion about investing.


    The first podcast features two well-known investors, John Buckingham (Trades, Portfolio) of Al Frank Asset Management and David Rolfe (Trades, Portfolio) of Wedgewood Partners. They have a conversation with GuruFocus about the state of iPhone maker Apple and answer some bearish questions.

      


  • Ron Baron Buys Under Armour in 2nd Quarter

    Ron Baron (Trades, Portfolio), founder of Baron Asset Management and co-portfolio manager of the Baron Partners Fund, invests in companies using a long-term investing approach.


    The fund seeks capital appreciation through focused research on the company’s management and long-term growth opportunities. During the second quarter, Baron took stakes in Under Armour Inc. (UA.C), Red Rock Resorts Inc. (NASDAQ:RRR) and MGM Growth Properties LLC (NYSE:MGP). Additionally, the fund manager increased his position in Gaming and Leisure Properties Inc. (NASDAQ:GLPI).

      


  • David Rolfe Takes 2 in Growing Retail Industry

    David Rolfe (Trades, Portfolio), chief investment officer of Wedgewood Partners Inc., increases value to his shareholders using an “index investing” approach.


    Through strategic stock selection and investment in industries with potential for sustainable growth, the managers of the St. Louis-based mutual fund seek to outperform competing mutual funds and the Standard & Poor’s 500 index. During the second quarter, Rolfe invested in two retail companies: Ross Stores Inc. (NASDAQ:ROST) and TJX Companies Inc. (NYSE:TJX). With these two transactions, Wedgewood's chief investment officer increased his portfolio by 5.1% in the aggregate.

      


  • David Rolfe Comments on Perrigo

    During the quarter, a surprising decline in Perrigo (NYSE:PRGO)’s normally staid generic prescription (Rx) business had the Company reduce full-year guidance by almost 15% in a late-April pre-earnings release. In addition, the Company disclosed further write-downs and organizational changes in their nascent Branded Consumer Health (BCH) segment. Last, the Company announced the abrupt exit of long-time CEO, Joe Papa, who joined embattled Valeant Pharmaceutical. Immediately after this slew of disconcerting data points, we decided it prudent to liquidate our Perrigo stake.


    We think that, at its core, Perrigo’s U.S. private label over-the-counter (OTC) business is intrinsically attractive, with nearly 70% market share and long-tailed revenue streams similar to that of a consumer staple. Private-label OTC was about 50% of the Company’s calendar 2015 revenue, and nearly 40% of consolidated operating profitability.

      


  • David Rolfe Comments on Ross Stores

    We also purchased shares of Ross Stores (NASDAQ:ROST) during the quarter. Ross is the other uniquely profitable off-price retailer, with nearly 1500 locations in 34 US states. Like TJX, we think Ross’s value chain is tailored to deliver a “more for less” value proposition for its customers. However, unlike TJX, Ross skews to a much more moderate income buyer who is looking to find “value” more than fashion. We find evidence that Ross’s catering to this demographic requires substantially different investment and operational activities. For instance, nearly half of Ross’s inventory is “packaway” inventory, which is typically more fashion-oriented merchandise that was purchased from vendors and kept in storage, to be deployed to store floors at a later date (sometimes the following season, but rarely more than a year). In the meantime, the “flow” that makes up most of Ross’s turnover consists of less well-known fashion brands but at price points that still represent great value relative to full-price retailers. In contrast, we do not think TJX has a meaningful packaway strategy, instead tailoring their merchandise flow to be fashion- oriented most, if not all, of the time. Further, Ross operates a very moderate priced concept, DD’s Discount, with average unit retail (i.e., the price of an item at checkout) closer to dollar stores, which is about half the price of our estimate for TJX’s average unit retail.


    We expect Ross to continue investing and expanding its core Ross Stores concepts and DD’s Discount stores across the U.S., as well as eventually enter into international markets, with room to double their existing footprint. Along with a multi-decade history of routinely positive comparable store sales, we expect that Ross’s growing footprint should lead to healthy high-single-digit revenue growth, while margin expansion and buybacks help drive mid-teen EPS growth.

      


  • David Rolfe Comments on Apple

    Apple (NASDAQ:AAPL) has been a significant underperformer not only during the recent second quarter (-11.8%), but also for nearly a year now. The stock has fallen about - 28% on an absolute basis, from its high set back on July 20, 2015. This is the second time that the stock has been put through the wringer since late 2012 on fears of “peak” iPhone growth and the concomitant lack of innovation out of the skunk works in Cupertino. Given the surge of sales of the iPhone 6 in 2015 (pent up demand for a larger iPhone, plus significant demand from China), we are not surprised by the weaker year-over-year earnings comparisons.


    The Apple stock advance-and-decline narrative has been pretty straightforward over the past half-dozen years. Given the consented narrative that Apple is “The iPhone Company” – and nothing but the iPhone – when forward analyst estimates of iPhone sales increase, the stock typically advances. When estimates are being cut, well, the stock typically declines, also. Mr. Market really is that binary on Apple’s stock price movements. We would argue, too, that Mr. Market is quite obtuse when it comes to the totality of Apple. Everything else that a rational investor would consider in accessing Apple as an investment is literally put in a vacuum when it comes to the stock. Valuation seems to matter not a wit. By any traditional valuation measure, both absolute and relative to other technology hardware companies, Apple’s stock, in our view, has long been cheap – but it gets cheaper still on estimate cuts. In fact, we would argue that Apple’s stock is currently valued (6.5X FCF ex-cash)2 as if to assume that the Company’s business prospects are little better than a coal mine in 10-year run-off mode.

      


  • David Rolfe Comments on Stericycle

    Stericycle (NASDAQ:SRCL) was also a top detractor during the second quarter. Stericycle’s early-year bounce reversed itself and then some after management lowered forward earnings expectations for the second time in three quarters. Management noted further weakness in their small (~3% of revenues, we estimate), industrial hazardous waste business, and pushed the timeline of about $20 million of expected synergies from their newly acquired document destruction business into next year. Taken alone, we think the stock’s -21% reaction following the earnings release was an overreaction.


    We think Stericycle’s core business of regulated waste management continues to be very attractive, throwing off strong free cash flow, with historically steady results. The Company has consistently reinvested these cash flows into smaller, regulated waste management acquisitions, as well as entering new verticals. Secure document destruction is a relatively new vertical for the Company, but we think the demand characteristics (driven by regulatory requirements) and hub -and-spoke collection and disposal model should fit well over the long term. While management noted a longer than expected timeline for converting on-site processing into off-site processing (similar to the way that medical waste is handled), we expect the Company will be successful in this conversion. As for the Company’s industrial hazardous waste business, it has proven to be highly cyclical. However, we expect the benefits of the Company’s overall hazardous waste platform (acquired in 2014) to more than outweigh the risks, as we estimate that retail and medical hazardous waste have grown to over 5% of revenues, from close to zero in 2014 – more than offsetting industrial waste declines. So while we understand investors’ concerns over the Company’s near-term earnings disappointments, we continue to be patient because we think Stericycle’s long-term opportunity for double-digit growth is intact as returns on reinvestment take hold.

      


  • David Rolfe Comments on Perrigo

    Perrigo (NYSE:PRGO) detracted –1.04% from the composite's absolute performance. A surprising decline in Perrigo’s normally staid generic prescription (Rx) business had the company reduce full-year guidance by almost 15% in a late April pre-earnings release. In addition, the Company disclosed further write-downs and organizational changes in their nascent Branded Consumer Health (BCH) segment. Last, the Company announced the abrupt exit of long-time CEO, Joe Papa, who joined embattled Valeant Pharmaceutical. Immediately after this slew of data points, we decided it prudent to liquidate our Perrigo stake.

    From David Rolfe (Trades, Portfolio)'s second quarter 2016 Wedgewood Partners Client Letter.   


  • David Rolfe Comments on Schlumberger

    Schlumberger (NYSE:SLB) contributed .42% to composite performance during the quarter. Despite the dramatic decline in exploration and production (E&P) capex budgets during the past 18 months, Schlumberger continues to reinforce its competitive positioning relative to other integrated oil service companies. With one of the largest, most highly-skilled upstream workforces in the private sector, and nearly $7 billion in cumulative research and development spent during the previous up-cycle, we think Schlumberger is poised to take an increased budget share of E&P spending as the Company’s customers outsource more services to improve returns in a “lower-for-longer” oil price environment. We expect Schlumberger’s earnings to significantly rebound in 2017, driven by increased market share as well as the release of over two years of pent-up E&P spending.

    From David Rolfe (Trades, Portfolio)'s second quarter 2016 Wedgewood Partners Client Letter.   


  • David Rolfe Comments on Express Scripts

    Express Scripts (NASDAQ:ESRX) was a top contributor during the quarter. The stock recovered some of the poor performance from the first quarter after Anthem management noted that, despite filing a lawsuit over Express Scripts’s pricing, they believed any ruling on the lawsuit would take several years and were still open to negotiations. Express Scripts is the sole, independent pharmacy benefits manager (PBM), which we think is key for maintaining their alignment with customers. We continue to expect Express Scripts to drive mid-to-high single-digit EBITDA growth using its scale to negotiate better pricing with drug manufacturers and service providers, while increasing patient adherence. We think earnings per share can continue to grow at a double-digit rate as shares are repurchased at what, in our view, are attractive valuations. That said, as shares rallied from their previous lows, we reduced the stock's weighting to better reflect the risk/reward of Express Scripts’s growth and valuation.

    From David Rolfe (Trades, Portfolio)'s second quarter 2016 Wedgewood Partners Client Letter.   


  • David Rolfe Comments on Kraft Heinz Company

    Kraft Heinz Company (NASDAQ:KHC) was a top performer during the quarter. First quarter adjusted EBITDA grew 21% year over year and earnings per share grew 38% year over year, as the Company’s consolidated adjusted EBITDA margins reached 30%, up a staggering 600 basis points from the year ago period. We estimate that these margins are best-in-class for the large-cap food products sub -industry, and nearly twice the median. In our view, the vast majority of large capitalization food product competitors, despite possessing great brands, are improperly incentivized, and are content to generate revenues at the expense of profits and long-term shareholder returns. In contrast, we continue to be impressed by Kraft Heinz’s new management culture, as recently brought to bear by 3G Capital and Berkshire Hathaway, which aggressively aligns management and employee incentives with shareholders. For example, rather than simply cutting overhead costs, the Company is intently focused on eliminating financial promotions for retailers (that frequently resulted in profitless revenues) and then reinvesting the savings into alternative product support, such as new products, form factors, and ad campaigns. We are seeing nascent evidence that this profit-focused strategy can be successfully executed without sacrificing revenue growth, as the Company posted low single-digit constant-currency organic revenue growth. As Kraft Heinz continues its aggressive new approach of reinvestment, we expect organic revenue growth to accelerate, along with continued margin expansion.

    From David Rolfe (Trades, Portfolio)'s second quarter 2016 Wedgewood Partners Client Letter.   


  • David Rolfe's Wedgewood Partners 2nd Quarter 2016 Client Letter

    "I think a lot of the market reaction is less about the financial impact and more about populism and what it means for the liberal economic order. The Brexit vote reflects a deep distrust of the benefits of the global economic system among a wide swath of voters in Europe and the United States, and a broadly held view that government institutions – whether in Washington or Brussels – are calcifying and don't work well. Both of these forces have a lot of wind at their back."

      


  • David Rolfe Nearly Divests Stake in M&T Bank

    Technology and Financial Services are the two most heavily weighted sectors in the portfolio of David Rolfe (Trades, Portfolio) of Wedgewood Partners Inc., and the guru was active in both in the first quarter.


    Rolfe’s largest first-quarter transaction was a near divestiture of his stake in M&T Bank Corp. (NYSE:MTB), a financial services company based in Buffalo, New York. Rolfe sold 3,068,523 shares for an average price of $108.61 per share. The deal had a -6.38% impact on Rolfe’s portfolio.

      


  • Caxton Associates Buys Coca-Cola, Goldman Sachs

    Caxton Associates (Trades, Portfolio) manages a portfolio of $1.42 billion composed of 112 holdings. During the first quarter he bought shares in the following stocks:


    The investor raised its shares in The Kraft Heinz Co. (KHC) by 451.12% with an impact of 14.51% on the portfolio.

      


  • Tom Gayner Sells Out of Coach

    Guru Tom Gayner (Trades, Portfolio), CEO of Markel (NYSE:MKL), sold his 54,000-share stake in Coach Inc. (NYSE:COH) in the first quarter.


    Started in 1941 as a family run workshop in New York City, Coach was a pioneer in leather goods, establishing itself as the original American house of leather during the second half of the 20th century. Its products include women's and men's bags, women's and men's small leather goods, business cases, footwear, wearables including outerwear, watches, weekend and travel accessories, scarves, sunwear, fragrance, jewelry, travel bags and other lifestyle products. Coach operates in two segments, North America and International.

      


  • David Rolfe's Lengthy Analysis of Berkshire Hathaway

    Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B)

    "We want to do business in times of pessimism, not because we like pessimism but because we like the prices it produces. It's optimism that’s the enemy of the rational buyer. We do not measure the progress of our investments by what their market prices do during any given year. Rather, we evaluate their performance by the two methods we apply to the businesses we own. The first test is improvement in earnings, with our making due allowance for industry conditions. The second test is whether their moats (competitive advantages) have widened during the year."

    Warren Buffett (Trades, Portfolio)

    We have owned shares of Berkshire Hathaway nearly continuously since the end of December 1998. (We exited the shares for a brief period after the share price spiked when the stock was added to the S&P 500 Index in early 2010.) Since our initial investment, the stock has meaningfully outperformed the S&P 500 Index by a factor of better than three- fold (+214% vs. +67%), buoyed by the tailwind of significant corporate growth. An aside: alert readers will note, if not recall, the significant underperformance of Berkshire stock during the first quarter of 2000 at the height of the dot-com bubble. Perhaps recalling too, the cover stories in the financial press then that the new new-world investing had laid waste to dinosaurs like Buffett. Well...Berkshire shares bottomed literally within days of the top in the NASDAQ. Since that seminal bottom 16 years ago, Berkshire shares have gained +292% versus a paltry gain of just +34%. (Cisco Systems has declined -65% since March 30, 2000.) Valuation matters.

    Over the course of our decade and a half investment in Berkshire Hathaway, the most common question we have been asked on any stock we have owned – and continue to be asked to this day is – “Is Berkshire Hathaway a “growth" company?" We attempted to answer

    this question back in early 2004 in a Client Letter titled, “Berkshire Hathaway: The Greatest Growth Company Wall Street Never Heard Of” (as excerpted):

    “Even casual students of Buffett have long since learned that Berkshire Hathaway is quite a different entity than it was only ten years ago. Where once Berkshire was not much more than Buffett’s personal investment portfolio, the Company is now a conglomerate of mutually exclusive businesses, dominated by a core of insurance companies. Wall Street is not casual about anything. When it comes to Berkshire and Buffett, Wall Street has finally caught on to the reality that the Company is mainly a conglomerate of businesses. Wall Street does not slavishly follow every Buffett buy and sell as Holy Grail secrets any more.

    “That said, we still think Wall Street once again remains behind Buffett’s learning curve.

    We believe that the Street fails to realize that Buffett has slowly built Berkshire Hathaway into a true growth company. In fact, not only is Berkshire a growth company, but a remarkably rapid one considering the enormous asset base ($180 billion) and equity base ($78 billion). Would anyone believe that a conglomerate could grow operating earnings per-share by 28% compounded over the past five years? The key here is the term per-share. Wall Street worships the mantra of “growth.” Too many corporate executives are compensated far too largely for any type of growth – good growth or bad growth. Make no mistake about it: not every type of growth is good for shareholders.

    “Growth via acquisition and mergers is the most prominent means of growth, and often the most fraught with abuse (Enron, Tyco, WorldCom, etc.). Investors must also be aware of managements’ claims of “record” growth. Buffett reminds us that even a simple passbook savings account generates “record” growth every year.

    “This matter underscores a most underappreciated aspect of Berkshire: non-dilutive growth by acquisition. Buffett has a growing reputation, particularly among large family-owned private businesses, that Berkshire is a terrific home for them since Buffett will not dismantle what these families have built over the years. More to the point, mediocre businesses become good businesses under the Berkshire umbrella. Moreover, good businesses become great businesses. We cannot stress this point enough.

    “The simple but powerful reason for this is that Buffett dramatically changes the reinvestment equation for Berkshire’s wholly-owned companies. Consider the capital reinvestment plight of a good -sized carpet or brick manufacturer. Now such a business may be considered a “good” business by measures such as profitability and market share, but unless the respective CEO can reinvest retained cash earnings accumulated in owner’s equity to earn future high returns, such businesses fail to be true “growth” companies. Of course, the carpet CEO or brick CEO can pay out all net earnings as dividends, but this is unlikely; since most CEOs are paid in part (in too many cases, in large part) on the size of the firm. Then the reinvestment of earnings becomes the paramount job of the CEO. So, what is the CEO to do if reinvestment opportunities back into the business are lackluster? Not much. This “lack of sustainable growth” is the simple reality facing the majority of Corporate America. Most businesses, by economic reality, cannot achieve growth much better than their underlying industry growth, or faster than the overall economy. We have stated for years that true growth companies are rare.

    “Consider the capital reinvestment options if our carpet/brick company is wholly-owned under the conglomerate of Berkshire. Buffett solves the reinvestment conundrum unlike almost any other business we know of. Sure, Buffett can allow CEOs to reinvest in carpets or bricks – but only if the CEO can convince Buffett that these reinvestment opportunities are superior to Buffett’s exceptionally wide canvas of reinvestment opportunities. This is highly unlikely since Buffett can invest in any asset, stock or bond, private or public company, or do nothing and just sit on wads of cash. Rare is the CEO who sits on stacks of idle cash. Too many CEOs view any and all activity as progress.

    “This is why businesses become better as a wholly-owned subsidiary of Berkshire. Buffett solves the ever-present capital reinvestment dilemma: this is the unique essence that too many investors fail to appreciate about Buffett and Berkshire Hathaway.

    “Now back to that pesky matter of “per-share” growth. Berkshire’s growth has been driven in large part by acquisition. However, Buffett – unlike most companies –rarely uses Berkshire stock to fund an acquisition. Therefore, as Buffett reinvests Berkshire’s many billions of cash into seemingly boring, but profitable businesses, revenues grow, earnings grow and cash flow grows. But since outstanding shares do not grow, per-share growth explodes. Per-share earnings have compounded at 28% for the past five years and 24% for the past ten years.

    “So, make no mistake about it –Buffett has masterfully built Berkshire Hathaway into an outstanding growth company.

    We would change little in that Letter. However, we did miss a few key elements. We failed to mention the evolving, solidifying culture of management redundancy and independence at each wholly owned business. Buffett ain’t making chocolates at See’s Candies, and he ain’t driving locomotives at Burlington Northern (though he probably wouldn’t mind such gigs from time to time). We failed to mention too the swiftness and tax efficiency with which billions can move throughout the Company’s conglomerate structure. A huge, and hugely underappreciated, element of Berkshire’s key enduring competitive advantages particularly the durability of the Company’s + $87 billion of insurance float. We would also add, after another decade of Buffett and Munger adding new diverse streams of revenues, earnings, and cash flow in very long-lived assets via acquisitions, plus significant organic growth within the Company’s best-in -class insurance operations, that Berkshire Hathaway has become what capitalism may have never contemplated, a perpetual growing cash flow machine. Notable acquisitions over the past decade ISCAR, PacifiCorp, Burlington Northern, Marmon, Lubrizol, Bank of America, Heinz, and, most recently, Precision Castparts. We do not type such words lightly, but as long as the Company retains all of their earnings (no dividends) for additional future acquisitions, the compounding will continue.

    The 50 - year compounding of Berkshire Hathaway on a per-share basis is without peer in the annals of capitalism. Many have tried to build conglomerate empires over the many years, but few have survived. Fewer still that might have the lights still on are but a shell of their former short-term glory selves. Wall Street has a long history of feeding and promoting faux empire builders who ultimately choke on too much dilutive common stock, too much easy debt, too many accounting schemes, too many lousy businesses acquired – and far too much fraud. Inevitably, the investment bankers stop calling (or returning calls) and the empire-builder CEO now must try to manage their colossus for organic growth and some semblance of true cash flow generation. At best, the colossus has morphed into a colossal mess (envision herding cats). At worst, the jig is up and the lawyers start calling. Berkshire Hathaway is the antithesis of this litany of conglomerate woe.

    The table below outlines the growth of a number of fundamental metrics since we first began investing in Berkshire, as well as more recent growth.

    A couple of observations hopefully stand out in the table above, but first a few notes. Assets, Revenues, Pre-tax Operating Earnings and Insurance Float are in millions. The shares outstanding are A- share equivalents. All per-share figures have been converted to 1/1500 B share equivalents.

    Observations since 1998:

    The 25X increase in pre-tax operating earnings per share illustrates the dramatic transformation of Berkshire from a “closed-end stock fund” into the mighty conglomerate it is today. Over the past 17 years, shares outstanding have only increased 8%.

    Insurance float increased a terrific +285%, but the change in float during 1998 was substantially increased by roughly $15 billion with the acquisition of Gen Re. Growth in float from year-end 1997 was +1,137%. Also of considerable note in June of 1998, Buffett swapped shares of Berkshire for shares in the purchase of Gen Re. At the time when the stock of Coca-Cola was valued at an incredibly rich +40X earnings and the Company’s equity portfolio alone made up 115% of book value, Buffett swapped Berkshire stock valued then at 3.0X book value, which tripled the Company’s float and “sold” stocks and “bought” a very huge fixed income portfolio. One of the greatest tax-free market-timing and asset allocation moves of all time.

    Investments per share “only” grew at a rate of 235%, yet this is far below the other conglomerate-related metrics.

    Observations since 2011:

    In an environment where the GAAP earnings of the S&P 500 Index companies was flat (see graphic below), Berkshire increased their pre-tax operating earnings per share by +63%, as well as reloading Buffett’s elephant gun (investments per share) by +62%.

    Growth in shares outstanding that included the following acquisitions: Bank of America warrants ($5 billion), Heinz ($12 billion), and Precision Castparts ($32 billion)? Zip. Zero.

    While not shown, sourcing the Company’s Statement of Cash Flows, specifically cash flows from investing activities less depreciation has collectively amounted to $101billion since 2011. Post-Precision Castparts, Buffett's annual cash for elephant and gazelle hunting should now exceed $25 billion per annum.

    When we consider the current weak economic environment, and the concomitant weakening environment for corporate earnings, we expect Berkshire’s enduring earnings growth to be a standout among the largest market cap companies. Bloomberg reports that U.S. corporate EPS growth has been falling since the second quarter of 2014 and has been increasingly negative for the past twelve months. In addition, factor in, that, according to Standard & Poor’s, Apple alone has contributed 22% of the S&P 500’s margin expansion. Remember, too, that these earnings per share fiqures are populated with plenty of convenient measures such as “adjusted net income,” “adjusted sales,” and “adjusted EBITDA.” Berkshire is quite unique too within their aforementioned long-lived assets. Utilities, pipelines and railroad assets consume many billons in annual capex expeditures. Accelerated depreciation is in effect a “tax-free loan.” As Berkshire continues to grow Property, Plant and Equipment faster than depreciation, deferred tax liabilites will continue to grow too. Over the past dozen years the Company’s defferred tax liability for PP&E has grown 30X from about $1.2 billion to over $36 billion. Said another way, Berkshire’s GAAP earnings are meaingfully understated. If you want earnings clarity, just follow the money – i.e., cash. The cleanest, most conservative accounting is routinely found in Omaha.

    Over time, this asymmetrical accounting treatment (with which we agree) necessarily widens the gap between intrinsic value and book value. Today, the large – and growing – unrecorded gains at our “winners” make it clear that Berkshire’s intrinsic value far exceeds its book value. That’s why we would be delighted to repurchase our shares should they sell as low as 120% of book value. At that level, purchases would instantly and meaningfully increase per-share intrinsic value for Berkshire’s continuing shareholders.

    Warren Buffett (Trades, Portfolio)

    2015 Chairman’s Letter to Shareholders

    We have also put together a table to track the growth in the intrinsic value of Berkshire’s stock since the 9/11 terrorist attacks in 2011; Berkshire recorded over a $2 billion loss that year. Working backwards, the last column is the pre-tax earnings of the Company’s various and numerous non- insurance subsidaries. The second to last column is the pre-tax earnings of Berkshire’s Ft. Knox-like insurance companies. Total Insurance is simply the sum of the prior two columns – Underwriting Profit plus Investment Income. Float and Float Growth are self-explanatory.

    The fun starts with columns 2 through 4. Regular readers of Buffett’s Chairman’s Letter will recognize the variables that Buffett regularly publishes on how he and Charlie Munger (Trades,Portfolio) determine the Company’s intrinsic value (IV). Buffett breaks down the Berkshire conglomerate into just two parts. The first (column 4) is the Pre- Tax Operating Earnings of the Company’s non-insurance businesses. The third column represents the Company’s Investments Per Share. Since most of the Company’s investments reside on the books of the Company’s insurance companies, In vestments Per Share is a very good, but arguably conservative measure if the compostion of the investment portolio is largely made up of higher-quality, growing businesses. However, this measure could be aggressive if the portfolio is excessively valued at any given time.

    The most important element for an investor is to try to fiqure out the most fair multiple to capitalize the non-insurance part of Berkshire. We have chosen a pre- tax multiple of 10X, so the IV math for 2015 looks like this: 10 X $8.38 = $83.80, then add the insurance side + $107 = $190.8. With the stock at $142, the shares seem like a bargin relative to IV of prospectively $191.

    However, IV calculations are inherently imprecise. If we thought a fairer pre-tax multiple was, say, 12X – given what we believe are the Company’s significant and enduring competitive advantages – the IV would be a robust $208 per share. On the other hand, we must also recognize that we should be as conservative as possible in such calculations, so if we capitalize the non-insurance subsidiaries at, say, a 8X multiple, then IV is only $174.

    We do take significant clues from the words of Buffett on this critcal topic to help us determine a conservative – but not too conservative – calculation of fair value. Specifically, Buffett has stated that he would like to buy back billions in Berkshire stock at a minimum price-to-book value of 1.2X. Furthermore, and quite significant, Buffett has noted, without equivocation, the rewards to shareholders of such actions.

    Share buybacks are only advantageous to existing shareholders if they are executed below IV. In classic Benjamin Graham style and discipline, Buffett will only buy back Berkshire stock at a significant margin of safety. Book value at year-end sits at $104 per share. 1.2 X $104 comes to $125, so, $125 is Buffett’s fat pitch. If, say, IV is $174 (8X), then Buffett’s margin of safety is 28%. In our view, this is not fat enough. At $208 (12X) the discount is 40% - maybe on the high side for Buffet, perhaps not. At $191 (10X) the discount is 35% - a minimum margin of safety discount for Buffett in our view.

    Here are a few other observations to consider:

    For the first time, Buffett included insurance underwriting results in the calculation of non-insuranceoperating results. His decision, after 12 years of annual underwriting profits, speaks to his expectation of continued insurance profitability in the years ahead. This decision, well past due in our humble view, underscores the amazing insurance business that Buffett and Ajit Jain have built over the years. There is no comparison anywhere in the world in terms of size, sticky float, and profitability.

    When Buffett states that the largest IV value over book resides in the insurance companies, believe him.

    We have added underwriting profits in the calculation of PTOE/share for all years. The profits of the non-insurance subs eclipsed the insurance side for the first time in 2010 after the sizable acquisition of Burlington Northern. (The purchase of BNSF alone immediately increased the Company's pre-tax earnings by almost 40%, while only increasing the share float by just 6%.)

    Note the underwriting profits in 2006 and 2007, post-Katrina. If Berkshire could ever achieve such results on their current base of float, underwriting profits would approach $5.5 billion.

    In a world of zero to negative interest rates, investment income in excess of $4 billion is remarkable.

    What will Berkshire Hathaway look like at the end of the next 10 years? Well, if the Company continues to retain all earnings, and redeploys capital with the same demonstrated success and discipline, shareholder's equity could reach $650 billion and the stock's market capitalization could reach $1 trillion. We'll take such growth...

    From David Rolfe (Trades, Portfolio)'s Wedgewood Partners 1st Quarter 2016 Client Letter.  


  • David Rolfe Comments on Charles Schwab

    Charles Schwab (NYSE:SCHW)



    As our conviction in M&T Bank waned, conviction built in another previously held financial, Charles Schwab. We previously held Schwab, ultimately selling the stock for valuation reasons in late 2013, after the stock got well ahead of what we thought were solid fundamentals. Valuation was the driving factor for the sell approximately two years ago, and valuation was the driving factor for this most recent purchase. In other words, little has changed from a fundamental point of view. Schwab has maintained their low-cost leadership (per dollar of platform assets) by leveraging their independent open-architecture asset gathering platform, and scaling over $2.3 trillion in client assets across decades of technology investments. Schwab’s low- cost of servicing allows them to pass on lower fees to advisors and clients, which is a key advantage, particularly in the highly commoditized financial services industry. While Charles Schwab’s capital intensity has increased over the past several years, they continue to maintain industry-leading pretax profit margins. We expect Schwab to continue gathering assets at a mid-single digit organic growth rate, combined with continued expense leverage, and only modest help from the interest rate environment.

      


  • David Rolfe Comments on M&T Bank

    M&T Bank (NYSE:MTB)

    Our growth thesis for M&T Bank was predicated on the company’s ability to maintain its historically successful inorganic growth strategy. We purchased the stock in mid-2013 as the Company moved forward with it’s acquisition of Hudson City Bank (announced in August 2012). More than three years later, after extensive AML/BSA expenses (the company spent over $150 million to improve these systems in 2014 alone) and four extensions to the closure date, regulatory approval was finally granted and the acquisition was complete. Of note in the Fed’s approval, however, was a restriction stipulating that M&T Bank must fully integrate the Hudson City deal and cure all BSA deficiencies fully before pursuing further growth through acquisition. We fully expect the Company to follow through on the Fed’s requirements, but given how cumbersome and expensive it has been to integrate this acquisition, we are not convinced that future acquisitions will be any less cumbersome. Furthermore, we are concerned that future returns on acquisitions will be much lower than we initially expected. As such, we liquidated our holdings in M&T Bank.

    From David Rolfe (Trades, Portfolio)'s Wedgewood Partners 1st Quarter 2016 Client Letter.  


  • David Rolfe Comments on Perrigo

    Perrigo (NYSE:PRGO)

    Perrigo was a bottom performance contributor in the quarter, as the company reported a miss in its Branded Consumer Healthcare (BCH) segment. Management attributed the miss to execution issues and dedicated themselves to solving these problems over the coming quarters. We are willing to be patient; in the meantime, as we think that Perrigo’s core, private label OTC business is unique and should remain a healthy and sustainable source of internal capital.

    Perrigo’s BCH segment was established after closing on the acquisition of Omega Pharma (Belgium) in March 2015. Mylan’s hostile bid for Perrigo was launched a few weeks later, and did not conclude until mid-November. We think that Perrigo’s BCH execution issues are understandable (if not predictable), as management was admittedly distracted by fending off Mylan’s hostile bid for the Company during much of 2015. Over the next several quarters, we expect BCH to post improved results, as it is better integrated with Perrigo’s corporate planning cycle.

    From David Rolfe (Trades, Portfolio)'s Wedgewood Partners 1st Quarter 2016 Client Letter.  


  • David Rolfe Comments on LKQ Corp

    LKQ Corp (NASDAQ:LKQ)

    During the quarter, LKQ continued to execute on its mid-single digit organic growth plus M&A strategy. In addition, the Company provided a convincing case for its continued execution at their first-ever Investor Day. The Company also announced the acquisition of Pittsburgh Glass Works for $635 million in enterprise value and finalized the acquisition of the RHIAG group of Italy.

    LKQ is both the largest distributor of aftermarket collision parts in North America and the largest distributor of mechanical aftermarket parts in Europe. We think scale is critically important to most distribution businesses, and LKQ is no exception. In North America, LKQ’s primary customers are collision repair shops that often participate in volume programs organized by casualty insurers looking for low-cost but high-quality repair parts. These collision repair shops must turn their repair jobs over relatively quickly or risk losing out on volume business. As such, LKQ’s unmatched product availability and fulfillment rates are differentiators in the eyes of the Company’s customers, while cost -conscious insurers provide another impetus for low -cost, aftermarket collision parts demand, so we expect LKQ’s profitability to reflect the return on the inventory and distribution capital expenditure risks that LKQ takes on behalf of its customers.

    LKQ’s organic revenue growth consists of increasing the penetration of after-market parts to collision and mechanical repair shops, as well as increasing route density. Increasing this “base” off which LKQ can organically grow, is their long-held approach of acquiring several under-scale competitors per year. As we have seen over the past few years, LKQ has very little in the way of rival competition, and the industry is mature, so aside from integration risks, LKQ’s accretive growth from acquisition appears to be repeatable. While LKQ contributed to our outperform ance during the quarter, we continue to think that LKQ’s growth prospects are under-appreciated by investors.

    From David Rolfe (Trades, Portfolio)'s Wedgewood Partners 1st Quarter 2016 Client Letter.  


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