The first quarter of 2016 was flat in some places and down slightly in others, but we doubt most investors remember it that way. The carnage in January was harsh, and daily volatility has been high, so many likely think of it as a rough three months. Yet the last half of the quarter largely recouped the losses from the first half. Among the three broad indexes tracking our asset classes, one was up a small amount and the other two were down. U.S. large caps were up a small amount. On the other hand, domestic small caps slipped a bit and foreign stocks were down. When U.S. large caps are up while U.S. small caps and foreign stocks retreat, we generally think it says more about sentiment than economics. That is, U.S. large caps are seen as providing stability whereas small caps and foreign stocks are seen as more risky. The discrepancy between domestic value and growth indexes says the same. That is, growth indexes from the large-, mid-, and small- cap universe ranged from less than +1% up to down nearly -5%, while the value counterparts were up more than +1% to +4%. For more than a year investor sentiment has gone up and down without a strong trend.
This quarter, Ariel Discovery Fund rose +2.20%, ahead of the Russell 2000 Value Index’s +1.70% gain, as well as the +1.35% rise of the S&P 500 Index.
Some of our holdings had strong returns for the quarter. Machine-to-machine communications company ORBCOMM, Inc. (ORBC, Financial) continued the nice run it began in late 2015, rising +39.92%. There was not much news in 2016, but as we mentioned in late 2015, the unfolding story was only starting to take hold and should have long legs in our view. With its full satellite “constellation” launched and operational, the company’s once-considerable capital expenditures will dwindle and profits can now fall to the bottom line. We have been selling into strength but still own the stock. In addition, natural resources exploration and production company Contango Oil & Gas Co. (MCF, Financial) gained +83.93% as the price of oil recovered during the quarter. There was no other significant news beyond oil’s rebound—which was good news enough for Contango. Crude oil started 2016 at close to $37 per barrel, sank to a low of $26 in mid-February, then marched back above $40 before settling back a bit. Although the commodity essentially was flat, the rebound showed its year-and-a-half long slide has perhaps found a floor. We continue to think Contango has unrecognized value.
Other holdings slid in the short term. Gaming firm Century Casinos, Inc. (CNTY, Financial) slid -20.82% after a weak earnings report. Specifically, the company reported $0.03 in earnings per share, missing consensus estimates of $0.11—largely due to soft revenues. We continue to think the stock trades at a deep discount to its intrinsic worth and believe its long-term trajectory will surpass Wall Street expectations. Also, clean energy solutions provider Rentech, Inc. (RTK) dropped -36.93% amidst disappointing short-term earnings. Specifically, the company posted a loss of $0.48 after analysts predicted a loss of $0.08. As long-term owners of the stock, we know the business can be relatively lumpy and are comfortable with it. We continue to believe the market misunderstands the company, it structure and its promise.
In the first quarter of the year, we took advantage of early-year market volatility to make some significant changes to the portfolio by adding seven new positions and eliminating five positions in Ariel Discovery Fund. Newly initiated positions include the following: ArcBest Corp. (ARCB, Financial) is a well-managed freight transportation and logistics company that trades below book value despite being solidly profitable. Macro-economic concerns provided us with an opportunity to purchase a company with potential to achieve higher returns as it grows its asset-light logistics business. CRA International, Inc. (CRAI, Financial) is a global consulting firm that offers litigation, regulatory and financial consulting, as well as management consulting services. Trading below book value and with nearly 25% of the market cap in cash, we believe our investment has sizable downside protection. In addition, CRA International consistently generates cash and has solid long -term growth prospects. Digi International Inc. (DGII, Financial) is a machine-to-machine (M2M) hardware provider in transition. The new management team is working strategically to reposition the company for sustainable long-term growth. DGII currently trades well below book value and has approximately 50% of its market cap in cash. Movado Group Inc. (MOV, Financial) is a watch retailer and wholesaler with international presence that operates through its iconic brands, along with six licensed brands. The company has a clean balance sheet with a sizable cash balance. Outstanding leadership has enabled the company to generate solid returns in a very challenging environment. Undemanding valuation multiples add to our enthusiasm. Real Industry Inc. (RELY, Financial) is a holding company based in Southern California backed by notable investors, including Sam Zell. With over $800 million in federal net operating losses (NOLs), management plans to acquire cash generating, stand-alone businesses that can utilize the NOL asset. Its first major purchase was Real Alloy, an aluminum recycling company. We believe the value of Real Alloy alone is more than the current market capitalization of Real Industry. With the value of the NOLs, we see an asymmetric risk/reward opportunity. STRATTEC Security Corp. (STRT, Financial) designs, manufactures and sells automotive access control products. It has a clean balance sheet and trades near tangible book value. Additionally, advancement in automated cars should provide a tailwind, driving demand for STRATTEC products. Lastly, West Marine, Inc. (WMAR) operates retail stores for boating supplies and accessories. The company trades at a sizable discount to book value despite being profitable, and has a clean balance sheet with no debt and excess cash. West Marine is positioned to take advantage of an ongoing recovery in the boating industry. The companies we eliminated included Furmanite Corp. (FRM) which was acquired by Team, Inc. (TISI), a current portfolio favorite; as well as LeapFrog Enterprises, Inc. (LF) which agreed to be acquired by VTech for cash. We sold CSW Industrials, Inc. (CSWI) as we believe the spinoff from Capital Southwest Corp. (CSWC) reached full value. We initiated a small position in Broadwind Energy, Inc. (BWEN) last year, but lost confidence in the company’s ability to avoid losses and protect its asset base. Finally, we believe Vical Inc. (VICL) is deeply discounted and remains in our micro-cap portfolio. However, given its very small market capitalization and the opportunity to add the somewhat larger names below at similarly attractive valuations led us to eliminate it from this portfolio.
Given the relatively small changes in the market and economy, our outlook remains stable—as it has been for more than two years. We think the U.S. economy is sound, and more sound than many seem to think. In our view, domestic stocks are fairly priced with pockets of opportunity where pessimism is high. An obviously shaky China casts a huge shadow over the global economy. That said, we think international valuations are attractive and thus ideal for bottom -up stock pickers like ourselves—although the press and general public see the recent volatility as a significant negative. Sharp moves tend to mean big shifts in valuation, and on the downside that can create opportunities.
This commentary candidly discusses a number of individual companies. These opinions are current as of the date of this commentary but are subject to change. The information provided in this commentary does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security.
As of 3/31/16, ORBCOMM, Inc. constituted 6.2% of Ariel Discovery Fund; Contango Oil & Gas Co. 2.7%; Century Casinos, Inc. 3.2%; Rentech, Inc. 0.5%; ArcBest Corp. 1.1%; CRA International, Inc. 1.4%; Movado Group Inc. 0.5%; Real Industry Inc. 1.5%; STRATTEC Security Corp. 0.6%; West Marine, Inc. 0.6%; Furmanite Corp. 0.0%; Team, Inc. 4.8%; LeapFrog Enterprises, Inc. 0.0%; CSW Industrials, Inc. 0.0%; Capital Southwest Corp. 1.3%; Broadwind Energy, Inc. 0.0%; and Vical Inc. 0.0%. Portfolio holdings are subject to change. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of Ariel Discovery Fund.
The Russell 2000® Value Index measures the performance of the small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower price-to- book ratios and lower forecasted growth values. Russell® is a trademark of Russell Investment Group, which is the source and owner of the Russell Indexes’ trademarks, service marks and copyrights. The S&P 500® Index is the most widely accepted barometer of large cap U.S. equities. It includes 500 leading companies. Indexes are unmanaged, and investors cannot invest directly in an index.
Investors should consider carefully the investment objectives, risks, and charges and expenses before investing. For a current prospectus or summary prospectus which contains this and other information about the funds offered by Ariel Investment Trust, call us at 800-292-7435 or visit our website, arielinvestments.com. Please read the prospectus or summary prospectus carefully before investing. Distributed by Ariel Distributors LLC, a wholly owned subsidiary of Ariel Investments LLC.
