To Our Shareholders,
For the quarter ended March 31, 2020, the net asset value (NAV) per Class A Share of The Gabelli Value 25 Fund decreased 29.0% compared with a decrease of 19.6% for the Standard & Poor’s (S&P) 500 Index. Other classes of shares are available. See page 2 for additional performance information for all classes.
First Quarter Commentary
The first quarter of 2020 was one of the worst in stock market history, with the novel coronavirus that causes COVID-19 spreading rapidly around the globe, and societies everywhere responding with various forms of “social distancing,” culminating with most of the global economy being effectively shut down. First and foremost, our thoughts are with all those personally impacted by the virus, with either themselves or a loved one being afflicted, as well as those unemployed or furloughed as a result of business shutdowns. We applaud the heroic efforts of all of our health care workers, as well as those employed in other essential businesses, keeping our grocery shelves stocked, our public transportation running, and our waste collected.
Many questions about COVID-19 remain: will it wane with warmer weather? Will it become endemic like the flu? When might effective treatments and a vaccine be developed? The data we do possess from China, South Korea and Italy unfortunately suggest cases in the U.S. will continue to escalate sharply, but eventually moderate. Life in China, where the virus originated last fall, appears to be slowly returning to normal. The strain on the United States health care system will be severe and the death toll will likely be massive, but two dynamics give us hope. First, technology should allow us to track, treat, and defeat this virus faster than any in the past. Notably, technology has also offset some of the heavy burdens of quarantine – the citizenry of the Spanish Flu of 1918 did not benefit from e-commerce, remote working/learning or Disney+. Second, after some delay, all levels of government and most businesses and individuals are instituting the practices needed to flatten the infection curve, putting us on path to put COVID-19 behind us. Many private companies have already unveiled promising developments in terms of tests that provide rapid results, therapeutic treatments and even vaccines, though many of those will likely not be available until 2021 at the earliest.
The cost of closures and social distancing is considerable. The global economy has nearly ground to a halt triggering what will likely be a severe recession. Energy markets plummeted, with the problem compounded amid a dispute between Saudi Arabia and Russia, which led to oil output being increased amid the sharp drop in demand. While there will be significant pent-up demand on the other side of this crisis, fear will need calming, supply chains will require realignment, and balance sheets will demand repair. Government action – both monetary and fiscal – is crucial, and the CARES Act signed into law on March 27 is a good start in providing relief to both individuals and businesses. The Federal Reserve has slashed interest rates to near zero, and is also buying securities in a number of asset classes – treasuries, mortgaged backed securities, asset backed securities, corporate credit, loans backed by the Small Business Administration – in order to stabilize markets and the economy. Further fiscal stimulus will likely be needed, and we expect legislation directed at more medium to long term measures that can actually drive spending and demand (e.g., a long overdue infrastructure bill) as opposed to simply providing more relief. Ultimately this recession, like all prior, will birth a new expansion. We currently expect a return to growth in Q3 after a sharp decline in Q2, though the pace of recovery will depend on the effectiveness of both measures to contain and combat the virus, as well as measures to keep individuals and businesses afloat for when the economy opens up again.
While this one has been especially painful due to its quickness and severity, we are reminded that bear markets, like recessions, are necessary to the capitalist system, cleansing its excesses. Over the four decades plus history of our firm, there have been five bear markets ranging in length from three to thirty months. We had been anticipating a correction for some time, though the trigger for and pace of the decline – one of the most rapid in history – took us by surprise. The market has already quickly bounced into technical “bull market” status from its lows, though those lows could be re-tested as the case and death counts rise to alarming levels. Ever the world’s best discounting machine, the market will need clarity on a peak in cases and government fiscal action before a sustained rally. That could be anticipated at any point which is why an attempt to time the market could result in significant forgone profits.
Conclusion
We believe the market decline and volatility due to the economic fallout from COVID-19, and likely exacerbated by the prevalence of algorithmic and passive trading, has laid the groundwork for investors to again focus on fundamental stock picking. Capital preservation is especially important in bear markets. The market is offering bargains unseen since 2008. Some are opportunities to add to companies already owned, others are in companies and industries whose prior valuations put them out-of-reach. We continue to emphasize the basics: does a company’s business model remain sound? Does it have a strong enough balance sheet to withstand the short term pain? Is management focused on shareholder value? The situation changes daily, but we believe the best way to participate in the return of health and prosperity is to own a portfolio of excellent businesses.
Investment Scorecard
Top contributors during the quarter included Stockholm-based smokeless tobacco manufacturer Swedish Match (7.6% of net assets as of March 31, 2020) (+11%), which continues to produce and deliver products during the crisis. Long-time holding Newmont Mining (7.2%) (+5%), the world’s largest gold miner, reflected a flight to safety in gold which subsequent to the quarter reached prices not seen in eight years. Finally, asset manager Legg Mason (+34%) contributed positively, as it agreed to a takeover in February by Franklin Resources for $50 per share in cash.
The largest detractor from performance was the newly merged ViacomCBS (6.5%) (-60%). Like most traditional media companies, ViacomCBS (6.5%) is likely to see Covid 19 related and recessionary pressure on advertising, theatrical revenue and linear cable subscribers. Notwithstanding these headwinds, the company remains investment grade has substantial cost reduction opportunities. Detractors from performance also included Madison Square Garden Company (5.2%) (-28%), which has been impacted by the postponement and cancellation of sporting events and concerts; notably, the company completed the separation of its sports and entertainment units in April. Finally, American Express (4.2%) (-31%) declined as lockdowns impact consumer spending, especially in travel, and bad debt rises.
Let’s Talk Stocks
The following are stock specifics on selected holdings of our Fund. Favorable earnings prospects do not necessarily translate into higher stock prices, but they do express a positive trend that we believe will develop over time. Individual securities mentioned are not necessarily representative of the entire portfolio. For the following holdings, the share prices are listed first in United States dollars (USD) and second in the local currency, where applicable, and are presented as of March 31, 2020.
Honeywell International Inc. (2.0% as of net assets as of March 31, 2020) (HON, Financial) (HON – $133.79 – NYSE) operates as a diversified technology company with highly engineered products, including turbine propulsion engines, auxiliary power units, aircraft brake pads, environmental control systems, engine controls, communications and navigation systems, sensors, building automation, catalysts and absorbents and process technology for the petrochemical and refining industries and warehouse automation equipment and software. One of the key drivers of HON’s growth is acquisitions that increase the company’s growth profile globally, creating both organic and inorganic opportunities.
Liberty Broadband’s (2.6%) (LBRDK, Financial)(LBRDA, Financial) (LBRDK/LBRDA – $110.72/$107.00 – NASDAQ) principal asset is a 21% interest in Charter Communications, the second largest cable company in the United States. Liberty Broadband is the product of decades of financial engineering by cable pioneer Dr. John Malone, who effectively controls the company. Charter, currently operated by former Cablevision executive Tom Rutledge, successfully integrated the acquisitions of Time Warner Cable and Bright House and is now capitalizing on its broadband infrastructure advantage during a time of increasing internet usage. Almost one quarter of Liberty Broadband is owned by another Malone-related public entity knows as GCI Liberty (GLIB) which also counts a direct stake in Charter, 28% of Lending Tree and Alaskan cable and wireless operator General Communications among its assets. Given the overlap, there has been public speculation about an eventual combination of LBRD and GLIB.
Madison Square Garden Co. (5.2%) (MSG, Financial) (MSG – $211.41 – NYSE) is a live entertainment company whose assets include the New York Knicks, the New York Rangers, the Radio City Christmas Spectacular, the Tao restaurant group and the eponymous Madison Square Garden. These evergreen content and venue assets benefit from sustainable barriers to entry and long term secular growth. MSG completed the separation of its associated regional sports networks in September 2015. The company further separated into a Sports company (consisting of the teams) and an Entertainment company (consisting of MSG’s concert business, Christmas Spectacular, arenas and development assets including the Spheres in Las Vegas and London) in April 2020. As of result of Covid-19 related restrictions, the company suspended development of the Las Vegas Sphere. MSG Entertainment maintains a significant net cash balance.
MasterCard Inc. (1.3%) (MA, Financial) (MA – $241.56 – NYSE) is one of the largest electronic payments processing companies, providing services in more than 210 countries and territories. It continues to capitalize on the strong secular global trend of moving to electronic payments from traditional paper. For all of 2018, clients charged approximately $4.3 trillion. At the end of December 2019, cards in force totaled over 2.2 billion. Longer term, MasterCard is well positioned to increase revenue due to global growth in personal incomes, rapid increase in commerce, and movement to electronic payments.
Mondelēz International Inc. (1.8%) (MDLZ, Financial) (MDLZ – $50.08 – NASDAQ), headquartered in Deerfield, Illinois, is the renamed Kraft Foods Inc. following the tax-free spin-off to shareholders of the North American grocery business on October 1, 2012. On July 2, 2015, Mondelēz combined its coffee business with D.E Master Blenders 1753 to form a new coffee company, Jacobs Douwe Egberts, which is considering an IPO in 2020. Subsequently, MDLZ exchanged part of its stake in this coffee joint venture for 24% ownership in Keurig Green Mountain, which was acquired by an investor group led by JAB Holding Co. in March 2016 and combined with Dr. Pepper Snapple Group in 2018. Today, the majority of the portfolio, nearly 90% of its $26 billion of revenue, is derived from snacking and includes leading brands such as Oreo, LU and Ritz biscuits, Trident gum, and Cadbury and Milka chocolates. The company continues to execute against its plan to accelerate revenue growth, which may include complementary acquisitions.
Newmont Corporation (7.2%) (NEM, Financial) (NEM – $45.28 – NYSE) based in Denver, Colorado, is the largest gold mining companies in the world. Founded in 1921 and publicly traded since 1925, NEM is the only gold company included in the S&P 500 Index and Fortune 500. Newmont consummated a $10 billion stock for stock merger with Goldcorp in April of 2019 in which it acquired eight high quality gold mines in the America. We expect Newmont to produce approximately 6.5 million ounces of gold in 2020 at all-in sustaining costs of $850 per ounce. Post its acquisition of Goldcorp, Newmont is working towards turning around Goldcorp’s former underperforming assets and establishing a large, low-cost, well capitalized gold mining business which generates free cash flow at almost any gold price and has the capacity to grow production organically. As such, the company is in the process of cementing its position as the premier gold investment vehicle in the world.
Republic Services Inc. (4.4%) (RSG, Financial) (RSG – $75.06 – NYSE), based in Phoenix, Arizona, became the second largest solid waste company in North America after its acquisition of Allied Waste Industries in December 2008. Republic provides nonhazardous solid waste collection services for commercial, industrial, municipal, and residential customers in 41 states and Puerto Rico. Republic serves more than 2,800 municipalities and operates 189 landfills, 212 transfer stations, 340 collection operations, and 79 recycling facilities. Since the Allied merger, Republic has benefited from synergies driven by route density, beneficial use of acquired assets, and reduction in redundant corporate overhead. Republic is committed to its core solid waste business. While other providers have strayed into alternative waste resource technologies and strategies, we view Republic’s plan to remain steadfast in the traditional solid waste business positively. We expect continued solid waste growth acquisitions, earnings improvement, and incremental route density and internalization growth in already established markets to generate real value in the near to medium term, highlighting the company’s potential.
Sony Corp. (8.5%) (SNE, Financial) (SNE – $59.18 – NYSE) is a conglomerate based in Tokyo, Japan, focusing on direct-to-consumer entertainment products supported by the company’s technology. Sony is the #1 integrated global gaming company and we expect the gaming segment to contribute over 1/3 of total EBITDA (ex-financial) in 2020 following the much anticipated launch of the PlayStation 5, probably for the 2020 holiday season. Sony Music Recording commands #2 and Music Publishing #1 global share. Sony also operates the Sony/Columbia film studio, which is well positioned in the OTT streaming wars as a major supplier of high quality library shows like Seinfeld and new movies like Bad Boys for Life. It is an image sensor leader with over 50% global revenue share and is the dominant supplier to Apple iPhone. Sony’s Electronics business is a globally diversified cash cow. It also holds majority ownership of Sony Financial Services. Sony has net cash on its balance sheet enables the company to manage through COVID-19; online game usage has increased dramatically with stay-at-home restrictions but business such as movies are impacted by production stopping and releases delayed.
Swedish Match AB (7.6%) (SWMA, Financial) (SWMA – $57.42/SEK568.00 – Stockholm Stock Exchange) produces tobacco products that include snus and snuff, chewing tobacco, cigars, and lights. The company has been benefiting from the growth of the smokeless tobacco market in both Scandinavia and the U.S., as public smoking bans and health concerns are driving consumers to seek alternative tobacco products to cigarettes. In October 2010, Swedish Match combined its European and premium cigar portfolios with Scandinavian cigar and pipe tobacco company STG, creating a new company that should benefit from enhanced scale and synergies. In February 2016, STG went public via an IPO on the Copenhagen Stock Exchange, with Swedish Match fully exiting its stake by 2017. The company has a tobacco-free nicotine pouch product called ZYN that is growing rapidly in the US and Scandinavia, and is driving growth in its mass market cigar business through its new natural leaf products. In October 2019, the company’s General Snus brand was deemed a modified risk tobacco product (MRTP) by the FDA. We expect Swedish Match to continue to grow its cigar and smokeless business globally, and the company could be an attractive takeover candidate for a global tobacco company that wants to increase its presence in the smokeless segment.
The Walt Disney Company (1.4%) (DIS, Financial) (DIS – 96.60 – NYSE) is a diversified media company with operations in cable network television, television broadcasting, filmed entertainment, theme parks and consumer products. The company recently pivoted to launching direct-to-consumer video services led by Disney+. While the company is temporarily hampered by Covid-19 related shutdowns of its theme park and cruise operations and the suspension of live sports coverage, with leading intellectual property across its Pixar, Marvel and Star Wars brands, few companies are as well-positioned to satisfy the entertainment demands of the next generation of consumers.
May 8, 2020
The views expressed in this Shareholder Commentary reflect those of the Portfolio Managers only through the end of the period stated in this Shareholder Commentary. The Portfolio Managers’ views are subject to change at any time based on market and other conditions. The information in this Portfolio Managers’ Shareholder Commentary represents the opinions of the individual Portfolio Managers and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. Views expressed are those of the Portfolio Managers and may differ from those of other portfolio managers or of the Firm as a whole. This Shareholder Commentary does not constitute an offer of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this Shareholder Commentary has been obtained from sources we believe to be reliable, but cannot be guaranteed.
