Meridian Funds Third Quarter 2013 Report
Stocks were strong during the quarter ended March 31, 2013, with most indexes reaching or approaching multi-year highs. For the quarter the S&P 500 gained 10.0%, the NASDAQ gained 8.2% and the Russell 2000, which includes smaller companies, gained 12.0%. This rally overcame mixed economic indicators and negative macro factors in the headlines, such as renewed European financial problems coming out of Cyprus and domestic issues such as sequestration. Support for equities came from the ongoing commitment to low interest rates and liquidity by the Federal Reserve, strength in home prices, resilient consumer spending and renewed interest in the equity markets from retail investors. Reflecting these mixed signals, the best performing sectors during the quarter were defensive in nature led by health care, consumer staples and utilities. Technology and basic materials were the worst performers. The yield on the ten-year Treasury bond ticked up modestly from 1.78% to 1.87% during the quarter as the economic outlook was essentially unchanged.
GDP grew at only 0.4% during the fourth quarter of 2012, a meaningful slowdown from 3.1% in the third quarter. The deceleration was driven primarily by downturns in private inventory investment and government spending, which reversed trends in the previous quarter, offset by an increase in non-residential fixed investment. Most economic analysts seemed to downplay this deceleration as the result of timing of government spending given the drama surrounding the fiscal cliff negotiations. Corporate profits are historically high, but growth appears to be slowing; expectations call for less than 1% earnings growth for S&P 500 companies for the first quarter of 2013. Slowing earnings growth presents a challenge for the equity markets, as we believe earnings growth is a more reliable catalyst for stock prices than other factors such as expansion of valuation multiples or merger activity.
We continue to follow our long established investment strategies and our stock selection discipline remains unchanged notwithstanding mixed signals from the economy and corporate profits. History clearly shows that long-term investment results are improved by buying good companies or mutual funds consistently over an extended period of time.
We welcome those new shareholders who joined the Meridian Funds during the quarter and appreciate the continued confidence of our existing shareholders.
Meridian Equity Income Fund® (MEIFX)
The Meridian Equity Income Fund's net asset value per share at March 31, 2013 was $12.15. This represents an increase of 12.3% for the calendar year to date. The Fund's total return and average annual compound rate of return since inception January 31, 2005 were 61.9% and 6.1%, respectively. At the close of the quarter, total net assets were $28,200,102 and were invested 1.5% in cash and other assets net of liabilities and 98.5% in stocks. At the close of the quarter there were 432 shareholders in the Equity Income Fund.
The Fund continues to invest in companies that we believe have the potential for capital appreciation and the ability to grow dividends. The Fund is diversified, with 49 holdings representing 42 different industry groups. At the end of the quarter ended March 31, 2013, the portfolio's average holding had a five-year average return on equity of 20.1% and an average dividend yield of 3.4%, both measures substantially higher than the average S&P 500 stock, with an average market capitalization of $36.2 billion and an average debt to capital ratio of 38.9%.
During the quarter we purchased shares of Campus Crest Communities, Chatham Lodging Trust, Compass Minerals International, Einstein Noah Restaurant Group, Innophos Holdings and Scotts Miracle-Gro Company. We sold our shares in Abbot Laboratories, Carnival, Diebold and Mine Safety Appliances.
Flower Foods (FLO), one of our larger holdings, makes fresh bread, snack cakes and pastries under the Nature's Own, TastyKakes and Mrs. Freshley's brands, among others. It is the second largest fresh bread company in the US and the largest in the Southeast. Competitive advantages include a low-cost manufacturing footprint of modernized bakeries and the industry's most efficient delivery network. We believe that above industry average growth should continue as Flower expands its delivery network in the West, Northeast and Midwest. Growth, in our opinion, should be augmented by the recent purchase of several bakeries and brands at attractive prices from bankrupt rival Hostess Brands. The current dividend yield is 2.1% and we believe future dividend increases appear likely based on attractive earnings growth prospects, a payout of less than half of forward earnings and historical dividend per share growth at a 15% five year compound annual growth rate.
Meridian Growth Fund® (MERDX)
The Meridian Growth Fund's net asset value per share at March 31, 2013 was $43.81. This represents an increase of 10.1% for the calendar year to date. The Fund's total return and average annual compound rate of return since inception August 1, 1984 were 2,981.6% and 12.7%, respectively. At the close of the quarter, total net assets were $2,167,911,226 and were invested 5.9% in cash, cash equivalents and other assets net of liabilities and 94.1% in stocks. At the close of the quarter there were 81,756 shareholders in the Growth Fund. We continue to follow the investment strategy that has served the Fund well for the past 28 years. Our portfolio remains diversified in mid-sized growth companies which in our opinion are predominantly market leaders, having strong returns on capital, solid growth prospects and that sell at reasonable valuations. The Fund is invested in 57 positions representing 30 industry groups along with Treasury Bills. Our heaviest areas of concentration continue to be the consumer and technology sectors.
During the quarter we purchased shares of Avago Technologies, FMC, Kirby, PerkinElmer and TIBCO Software. We sold our position in Family Dollar Stores.
Affiliated Managers Group (AMG), one of our largest holdings, is an asset management company that typically acquires a significant ownership in growing boutique investment firms while retaining key investment principals to continue managing the investment portfolios. Among many asset managers, the company is viewed as a preferred acquisition partner given its long term track record in growing acquired firms and providing an attractive incentive structure. Affiliated Managers has numerous growth drivers that, we believe, should enable it to grow faster than the industry including continued acquisition of new firms, further penetration into international markets, and expansion into new services such as wealth management. In our opinion the stock sells at a reasonable valuation given the company's strong management team, financial returns and long-term growth prospects.
Meridian Value Fund® (MVALX)
The Meridian Value Fund's net asset value per share at March 31, 2013 was $36.51. This represents an increase of 11.11% for the calendar year to date. The Fund's total return and average annual compound rate of return since June 30, 1995 to date were 932.0% and 14.1%, respectively. The comparable period returns for the S&P 500 with dividends were 298.7% and 8.1%, respectively. At the close of the quarter, total net assets were $718,379,444 and were invested 7.0% in cash, cash equivalents and other assets net of liabilities and 93.0% in stocks. At the close of the quarter there were 29,651 shareholders in the Value Fund.
We continue to seek out-of-favor companies, typically having experienced an extended period of declining earnings. Often these companies have experienced outsized declines in their stock prices as the market reacts to these earnings declines. We research these companies to determine the factors behind the earnings decline and evaluate the company's response. Ideal investment candidates are those that are poised to resume sustainable growth and that are trading at a reasonable valuation based on potential earnings. The Fund is invested in 56 positions, representing 34 industry groups along with Treasury Bills. We continue to invest in companies of all market capitalizations and our largest areas of concentration are technology, industrials and transportation.
During the quarter we purchased shares of AptarGroup, Compass Minerals International, FLIR Systems, Hospira, Humana, Innophos Holdings, Masimo, Scotts Miracle-Gro and Wolverine World Wide. We sold our positions in Carnival, Cintas, Costco Wholesale and International Speedway.
Huron Consulting (HURN), one of our larger holdings, is a leading provider of consulting services to the healthcare, higher education and legal markets. The company advises hospitals and universities on ways to cut costs, gain efficiencies and improve outcomes. Legal consulting helps companies reduce their outside legal costs. New management led Huron back from a sizable earnings restatement in 2009 with limited consultant turnover and its reputation intact. The company's healthcare practice benefits from the need for hospitals to become more efficient due to lower reimbursement rates, sluggish patient volumes and less high margin elective procedures. Hospitals will also need external advice in adapting to the changes enacted under the Affordable Care Act, including the shift from a fee-for-services payment model to pay-for-performance. We believe the company is a compelling value at 11x our $3.70 estimate of earnings power.
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The Meridian Funds are no-load and there are no transaction fees or commissions charged when you purchase shares directly through our transfer agent, BNY Mellon Investment Servicing (U.S.), Inc. This is a very cost-effective way to purchase shares of the Meridian Funds if you do not need the services of a broker-dealer or if you make multiple purchases.
The information provided in this report should not be considered investment advice or a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in a particular Fund's portfolio at the time you receive this report or that securities sold have not been repurchased. Securities discussed are presented as illustrations of companies that fit a particular Fund's investment strategy and do not represent a Fund's entire portfolio and in the aggregate may represent only a small percentage of a Fund's portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that investment decisions Fund management makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Management's views presented herein and any discussion of a particular Fund's portfolio holdings or performance are as of March 31, 2013 and are subject to change without notice.