Mairs & Power Growth Fund Q4 2014 Commentary

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Mar 31, 2015

Investors could be forgiven if they looked back on 2014 as a year of mixed signals. Concerns about slowing growth in China, a possible recession across Europe and increasing tensions with Russia over their aggressive moves against Ukraine all contributed to market uncertainty. On the other hand, earnings continued to exceed expectations and the rapid decline in energy prices put a tailwind behind the U.S. economy, rewarding investors with the sixth year in a row of positive returns and the longest run since the bull market of the 1990s.

With crude oil down more than 40 percent for 2014 (and continuing to fall in the first weeks of the New Year), we believe this will be the biggest driver of the U.S. markets and economy over the next several quarters. GDP growth in Q3 was revised upward to a healthy five percent annual rate, even before the stimulus of lower gas prices had fully kicked in, revealing continued momentum to the domestic economy as we enter 2015.

Such a rapid shift in the price of oil is, by definition, disruptive, creating winners and losers. As investors, we see both risks and opportunities as a result. A Goldman Sachs report recently estimated that the $1-plus drop in gasoline prices since last year will cut $125 billion from consumers’ fuel bills over the coming twelve months. Assuming low gas prices hold for the next several quarters, we see a healthy economic stimulus benefitting consumer- facing companies such as retailers, restaurants and entertainment. We also see industrial manufacturers and transportation benefiting from lower raw material and fuel costs.

Investment opportunities are created at times like this for those willing to “go against the flow” and at Mairs & Power we attempt to see opportunities where others may not. For example, one of our portfolio holdings, Wisconsin-based flexible package manufacturer Bemis Company, announced that a veteran within the company would succeed its retiring CEO last summer. We began talking to the new management early on and heard the new CEO articulate a clear understanding of the company’s opportunities and challenges as well as a good formula for success. In addition, we believe the company stands to benefit from falling oil prices. Ethylene prices, a key part of their raw material costs, have not yet responded, so the company can look forward to lower costs in the future. We feel the price advantage of flexible packaging relative to rigid packaging will accelerate the long-term shift away from cans and bottles to the more robust packaging that Bemis manufactures. As a result, we substantially increased our already established position. Once the rest of the market recognized what we had seen, the stock responded with a nearly 20% rise in the fourth quarter.

Future Outlook

We expect interest rates to begin rising sometime in 2015 which will have several effects that bear watching. We do not believe that a slight increase in rates would, by itself, end the current cycle. However, the advantage stocks have enjoyed over fixed income securities in the current low interest rate environment will be lessened as rates rise and investors find more places that offer yield.

The rate of growth for both revenue and earnings among small and large companies continues to be impressive. Furthermore, we believe that low energy prices will continue to benefit the U.S. economy over the next several quarters. When we look at the U.S. economy, we see no significant weaknesses. With the current cycle entering its seventh year and price to earnings ratios above their historic averages, we can expect positive, but muted equity returns for this year.

Growth Fund Performance

While the Growth Fund underperformed relative to its benchmarks for the full year, it finished on a strong note, outpacing those benchmarks in the fourth quarter. The Fund, for the quarter, was up 6.33% compared with 4.93% for the benchmark S&P 500 Total Return (TR) Index and 5.20% for the Dow Jones Industrial Average TR Index. For the full year, the Fund was up 8.12% compared with 13.69% for the S&P 500 TR Index and 10.04% for the Dow Jones Industrial Average TR Index.

The relative underperformance of small cap stocks compared with the large cap S&P 500 was one factor causing the Growth Fund, with a blend of small and large cap stocks, to lag its large cap benchmarks for the full year. The Fund’s underweight position in energy related stocks – the worst performing sector in both periods -- benefited fund performance for the quarter and the year. Overweight positions in the industrials and materials sectors were negative factors in Fund performance for the year.

The rapid decline in global oil prices in 2014 was a major factor in the Fund’s performance for both the fourth quarter and full year. Declining raw material and fuel costs benefitted industrial manufacturers such as 3M Company (MMM), which hit an all-time high in December and was a top performing stock for the quarter. Similarly, the drop in gasoline prices funded increased consumer discretionary spending, benefitting companies such as Target Corp (TGT). which also hit an all-time high in December and was a top performer for both the quarter and the year. On the other hand, the oil-field service company Schlumberger (SLB), was among the poorest performers for the fourth quarter and full year 2014, declining to valuation levels not seen in more than a decade.

The Fund, consistent with its investment discipline, selectively trimmed positions and took profits in those stocks which we considered somewhat overvalued while adding to positions where current valuations do not fully represent a stock’s long-term value.

Mairs & Power Growth Fund (MPGFX) Fourth Quarter Results (9/30/14 - 12/31/14)

TOP PERFORMERS
FOURTH QUARTER (9/30/14 - 12/31/14) YEAR TO DATE (12/31/13 - 12/31/14)
Cray Inc. 31.40% Corning Inc. 28.68%
Target Corp. 21.11% C.H. Robinson Worldwide, Inc. 28.37%
Bemis Co., Inc. 18.91% Medtronic, Inc. 25.81%
Medtronic, Inc. 16.55% Valspar Corp. 21.31%
3M Co. 15.98% Target Corp. 19.98%
WEAK PERFORMERS
FOURTH QUARTER (9/30/14 - 12/31/14) YEAR TO DATE (12/31/13 - 12/31/14)
Schlumberger, Ltd. -16.01% Pentair Ltd. -14.48%
Ecolab, Inc. -8.98% H.B. Fuller Co. -14.43%
Roche Holdings LTD -8.11% Emerson Electric Co. -12.04%
Donaldson Co., Inc -4.92% Donaldson Co., Inc. -11.11%
Johnson & Johnson -1.90% Schlumberger, Ltd. -5.22%

At regularly scheduled meetings in December, the Mairs & Power, Inc. Board of Directors and the Mairs & Power Funds Trust (Trust) Board of Trustees approved a number of changes to the company’s executive ranks and to the officers and trustees of the Trust. Among the changes, Andrew Adams joins lead manager Mark Henneman as co-manager of the Growth Fund, effective January 1st, Mr. Henneman has been appointed President of the Trust, effective December 31st. These executive changes culminate a long-term succession plan which began several years ago in anticipation of William Frels’ mandatory retirement on December 31, 2014 as co-manager of the Growth and Balanced Funds and Trustee and President of the Trust. The Mairs & Power Mutual Funds employ a deliberate and disciplined succession planning process to ensure consistency in the investment philosophy over time. Press releases detailing all the changes are available on the Mairs & Power website.

Mark L. Henneman Andrew R. Adams
Lead Manager Co-Manager

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