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Bill Nygren's Oakmark Fund First Quarter 2014 Commentary

April 08, 2014 | About:
Holly LaFon

Holly LaFon

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The Oakmark Fund increased 2% in the first quarter, fractionally exceeding the S&P 500 gain, which also rounded to 2%. For the first half of our fiscal year Oakmark Fund was up 14%, compared to 13% for the S&P 500. Additionally, the Fund ended the quarter at an all-time high price. Because our goal is to increase the capital of our shareholders, we are always pleased to report new highs.

After such a strong year for equities in 2013, we are not surprised to see returns moderate as we move into 2014. Stocks certainly aren’t as cheap as they were a year ago, but we are still finding attractive companies to add to the portfolio. At Oakmark, we’re big fans of the Chicago Blackhawks, so as we approach playoff time, we start to think about some of the best hockey clichés. One of our favorites is, “a two-goal lead is the worst lead in hockey.” While we are amused by the fragile logic of this statement, we appreciate the simple message that in a fast-paced, competitive environment, you can’t sit on a lead. At Oakmark, we have an amazing team of research analysts who have remained diligent in uncovering attractive investment opportunities. As you will see below, we added four companies to the portfolio during the first quarter that we think are high-quality and attractively priced.

The best performing stock in the quarter was Forest Laboratories (Forest), up 54%. Forest has been an incredibly successful investment for the Oakmark Fund, and we offer our congratulations to the company’s board and management team for maximizing per-share value for shareholders. It has only been one year since we first wrote about our purchase of Forest, and since then, the share price has increased 149%. Please refer to the Oakmark Select commentary for a more detailed description of our tax-efficient sale strategy for Forest. Another top performer was our largest position, Bank of America. We still think the financial services sector is attractively valued, and with Bank of America, we are pleased to see investors recognize better visibility of higher future earnings and an enhanced capacity to return excess capital to shareholders. Our worst performer was General Motors (GM), down 15%, due to what we believe was the market’s overreaction to GM’s handling of a recent product recall. We eliminated our position in Merck as the shares appreciated to our estimate of fair value.

Citigroup Inc. (C - $48)(C)
Like its universal bank peers, we think Citigroup is significantly undervalued relative to its normalized earnings power. Unlike its peers, however, it has two hidden sources of value, neither of which is reflected in GAAP earnings: a deferred tax asset and a larger base of excess capital that is growing at a rapid rate. We have long admired Citigroup’s global franchise and its growth potential. One of Citigroup’s key competitive advantages is its unique global reach. Citigroup has more than twice as many country banking licenses and direct local payment network connections as its closest competitor. As a result, we think Citigroup is uniquely positioned to offer corporate clients more visibility into their asset, liability and currency exposures, but requires fewer resources to manage the relationship. We would be remiss not to mention Citigroup’s recent Fed stress test results. Although the qualitative results were disappointing, its quantitative stress test results confirm our analysis that the company has significantly more excess capital than its peers. We expect this capital to eventually benefit shareholders either through capital return or smart balance sheet growth.

Diageo PLC (DEO - $125)(DEO)
Diageo is the world’s largest spirits manufacturer. Diageo has a portfolio of spirits brands that is among the best in the industry, including a leading scotch franchise that is nearly impossible to replicate. These strong brands are supported by the company’s global scale, which allows for meaningful efficiencies in manufacturing, distribution and marketing. As a result of these advantages, we believe Diageo will maintain its excellent competitive position. At the same time, revenues have grown consistently for years due to a combination of pricing power and emerging markets exposure, and this growth should continue for the foreseeable future. We believe this well-managed company is selling at a large discount to intrinsic value. Further, Diageo has a dividend yield of 2.5%.

General Mills, Inc. (GIS - $52)(GIS)
We believe General Mills is a high quality, well-managed packaged foods company with exposure to fast-growing product categories. The company has an impressive track record of stable earnings growth, and it has consistently returned most of its strong free cash flow to shareholders in the form of share repurchases and dividends. We think revenue and margins will continue to grow, primarily driven by its international business. The company has an attractive global cereal joint venture with Nestle, which often gets overlooked by investors. With consistent profit growth and a shrinking share base, we like its prospects for per-share value growth. In addition, General Mills has a dividend yield of 3.2%.

Sanofi (SNY - $52)(SNY)
Sanofi is a pharmaceutical company with a good mix of durable businesses with strong growth characteristics. The company has a strong franchise in diabetes treatments, maintaining dominant market share in this rapidly growing category. Sanofi is a leading player in emerging markets, where sales growth rates are twice that of the overall pharmaceutical market. Sanofi is also a leader in vaccines, and they have a strong footprint in over-the-counter products. We think that margins and profitability should improve as the company leverages fixed R&D spending and enforces good cost controls. The company’s balance sheet has more cash than debt, and the shares sell at a substantial discount to our estimate of intrinsic value. Moreover, Sanofi has a dividend yield of 3.7%.

William C. Nygren, CFA
Portfolio Manager
oakmx@oakmark.com

Kevin G. Grant, CFA
Portfolio Manager
oakmx@oakmark.com

As of 03/31/14, Forest Laboratories, Inc. represented 1.3%, Bank of America Corp. 3.1%, General Motors Co. 1.7%, Merck & Co., Inc. 0%, Citigroup, Inc. 1.3%, Diageo PLC 1.8%, General Mills, Inc. 0.8%, Nestle S.A 1.0%, and Sanofi 1.0% of the Oakmark Fund's total net assets. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

The S&P 500 Total Return Index is a market capitalization-weighted index of 500 large-capitalization stocks commonly used to represent the U.S. equity market. All returns reflect reinvested dividends and capital gains distributions. This index is unmanaged and investors cannot invest directly in this index.

The Oakmark Fund’s portfolio tends to be invested in a relatively small number of stocks. As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Fund’s volatility.

The discussion of the Fund’s investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Fund’s investments and the views of the portfolio managers and Harris Associates L.P., the Fund’s investment adviser, at the time of this letter, and are subject to change without notice.


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