In the quarter, we initiated a new position in Anixter International (AXE, Financial). We became very interested in the company as its stock price sold off from a peak of $106 in March 2014 to about $65 in July of this year, as investors became concerned about the economy slowing down and the negative effects of the strong U.S. dollar. Anixter is a global distributor and solutions provider for a multitude of cables, electrical wires and electrical and security equipment for offices and industrial plants.
Although distribution is a competitive business, Anixter offers a unique value-added business model for its customers. Anixter serves as a crucial link between some 1,600 wire and cable manufacturers and over 100,000 customers who buy some 450,000 types of wires, cables and related products .
The company positions its role as the manager of procurement, inventory management, quality testing, engineering advisory, and just in time delivery for the Fortune 1000 companies. As evidenced by its stable gross margin of between 22% and 23%, even during recession years, Anixter’s business is not a commodity competing purely on price. Thus, Anixter has been able to avoid the channel compression at other distribution industries where manufacturers have tried to eliminate the “middlemen”; its value added model has enabled it to stay above internet resellers focused solely on lower prices.
In the last 15 months, management made three major moves to reposition the company, which in our opinion secures its ability to grow its book value for the long term. In April  2014, Anixter acquired Tri-Ed, a leading distributor for state of the art electronic security products, for $420 million. In February it sold its sub-scale and European focused OEM Fasteners business for $380 million, exiting a non-core segment which freed up management’s focus and provided balance sheet liquidity. Most recently, it agreed to purchase HD Power Solutions in July for $825 million.
These three strategic actions substantially strengthen Anixter, by building scale in its core North American electronic distribution platform, while exiting an underscale unit which would have proven costly to grow.
The addition of Anixter’s new businesses should sustain its long-term organic growth rate at one and a half to two times U.S. GDP. While the net effect of these transactions increased the financial leverage of the company — debt to EBITDA rose from 2.5 times to 3.6 times — management has made debt reduction a near-term priority for its strong cash flow. We think management’s goals to reduce leverage back to historical ranges of 2.5 times in roughly 18 months are realistic and achievable.
Management has historically proven to be a good allocator of capital and has demonstrated an ability to create value. The company’s equity value grew 10% a year, over the last decade, when adding back all of the stock buy backs and special dividends. The recent sell-off in Industrials provided us with the opportunity to initiate a position at very attractive valuation levels. On a pro-forma basis, accounting for the recent announced HD acquisition, Anixter is trading at about six times our projection of 2016 EBITDA, at the bottom of its historical range of six to nine times. A conservative midpoint valuation of 7.5-times suggests over 30% upside to $80 per share. Our separate discounted cash flow (DCF) based analysis suggests an $85 per share value, as it incorporates Anixter’s stable free cash flow generation attributes.
These targets are both realistic and conservative. Portfolio sale activity included the disposition of our stakes in Michelin (ML, Financial), Daiwa and Valmont (VMI, Financial). As described in more detail in our Small-Cap Value Fund letter this quarter, having a robust sell discipline is a key tool for strong performance. We will sell when our price target is achieved, when we see a more attractive risk vs. return scenario, or when the original basis for our investment thesis has changed for the worse and we no longer have a compelling reason to own the stock. Michelin and Daiwa proved to be very successful investments for the Fund, and both were sold as share prices for these companies reached our conservative estimates of NAV. Conversely, we decided to reverse our decision on our Valmont initiation and sell the shares for a small loss.
Two risk factors that we identified in our initial analysis developed more negatively than we anticipated, i) the severity of the California drought which is impacting farm income and sprinkler sales in the region and ii) moreover, the continued drought of orders for long-haul transmission lines and the subsequent price competition for transmission tower structures that some of Valmont’s peers are pursuing. While we continue to have high regard for the management of Valmont, the earnings and balance sheet pressure on the company now appear to be more sustained than when we initiated the position, so we decided to redeploy the capital into other names, specifically our Anixter purchase which we described above. Essentially, the risk/ reward tradeoff of Anixter vs. Valmont presented a superior investment opportunity. In closing, we remain confident in the longer-term positioning of the Fund. We continue to see new investment opportunities, as well as the potential to increase the position sizes of certain Fund names.
We thank you for your trust and support and look forward to writing to you again at the end of our fiscal year in October.
Sincerely,
The Third Avenue Value Team Value Fund Chip Rewey, Lead Portfolio Manager Michael Lehmann, Portfolio Manager Yang Lie, Portfolio Manager Victor Cunningham, Portfolio Manager
