Quarter Ended June 30, 2017
It was another strong quarter for equities, one that was largely void of any major macroeconomic developments. First quarter earnings reported for the S&P 500 Index were up +15% year-over -year. Even more impressively, 78% of S&P 500 companies beat consensus EPS estimates. Additionally, last quarter’s revenue results had the biggest surprise to the upside since the fourth quarter of 2014. That said, Russell 2000 Index earnings were largely flat quarter-over-quarter. Overall earnings growth expectations for small-cap stocks have declined as valuations, particularly within financials, appear stretched. This quarter, Ariel Fund rose +0.06%, slightly behind the Russell 2500 Value Index’s +0.32% rise as well as the +2.13% return of the Russell 2500 Index.
Some stocks in the portfolio performed quite well. Zebra Technologies Corp. (ZBRA, Financial)—a leading global supplier of solutions to help companies track physical assets and make smarter decisions—gained +10.16% during the period, driven predominantly by strong earnings. We believe the company's brand strength, distribution network and resources devoted to innovation enable it to gain market share, earn industry-leading profitability, and penetrate new growth markets. We view the company as an industry leader with a strong management team, well -positioned to benefit from secular global demand for asset tracking solutions, especially in developing economies.
Another stand-out performer in the portfolio was JLL (JLL, Financial), a premier real estate services firm. It gained +12.49% during the quarter. Strength was consistent across almost all of the company’s business segments with only capital markets and asset management experiencing weakness. As a worldwide leader in a critical niche, where global scale and expertise is crucial to customers, we expect the company will continue to benefit from accelerating trends of globalization, the outsourcing of real estate services, and institutional demand for commercial real estate.
Some other holdings in the portfolio underperformed. Helicopter transport company supplier Bristow Group Inc. (BRS, Financial) declined -49.19% as continued oil price weakness and disappointing earnings weighed heavily on the stock. The company’s management team lowered guidance around profitability and accelerated necessary cost cutting. Despite this short-term weakness, management reiterated that it expected to see stronger results in the second half of the fiscal year as recent contract wins come online. Management also reaffirmed the firm’s commitment to maintaining total liquidity over $200 million, highlighting the successful renegotiation of the company’s short-term debt obligations late last year. We expect to see continued short-term volatility in the company’s quarterly earnings reports. While we recognize the company faces several headwinds, we do not believe it is facing any significant risk of insolvency. Continued weakness in the energy market will be a headwind to the company short-term. However, we believe the value of the helicopters that Bristow owns creates a potential margin of safety1, as the company’s assets exceed its current stock price.
Also detracting from performance was multinational media conglomerate Viacom, Inc. (VIAB, Financial), which saw its shares fall -27.59% during the period. The company reported adjusted EPS of $0.79 vs. consensus of $0.59, with revenues up +8% year-over-year. Despite the positive news, investors remain wary of the company’s ability to execute its strategic plan, as changing media consumption patterns and technology create more general concerns about the cable business model. Nevertheless, Viacom is the owner of valuable content, including children’s programming and comedy, and a leading movie production franchise with more than 3,300 motion pictures in its library. Despite critics’ arguments that fundamentals will remain negative at those media network companies serving kids and teens and at those lacking live sports programming, we believe Viacom’s content will provide attractive economics regardless of the distribution medium.
Nielsen Holdings Plc (NLSN, Financial), the global provider of critical data and analytics about what consumers watch and buy, was the lone addition to Ariel Fund during the quarter. The company’s television ratings are the de facto currency for media and advertising decisions totaling hundreds of billions of dollars globally. Its consumer purchase data is unmatched in scope and scale, and therefore mission-critical information for the world’s leading consumer packaged goods players. As both television viewership and purchasing behavior become more fragmented across online and mobile devices, investors are concerned that Nielsen’s dominance is at risk. But, in our view, this fragmentation only makes Nielsen’s data more valuable. As such, we see the current fears as an opportunity to own a market share leading information services brand with highly recurring and growing free cash flows. We did not eliminate any positions during the quarter.
As we look ahead, we remain cautiously optimistic about the economy. During our recent earnings calls, we noticed a shift from cost- cutting to top-line earnings growth, as well as increased optimism from company CEOs on the future of the economy, particularly within small companies. That said, we believe current valuations are difficult to overlook. As of June month-end, the S&P 500 Index traded at 18.5X forward earnings and the Russell 2000 Index traded at 19.3X forward earnings. While these figures are definitely above average, we do not yet consider them to be in dangerous territory. We remain disciplined with our approach and are confident in our portfolio positioning, which is at a deep discount relative to the indexes. Historical patterns have suggested this is a positive leading indicator for strong performance going forward.
1 Attempting to purchase with a margin of safety on price cannot protect investors from the volatility associated with stocks, incorrect assumptions or estimations on our part, declining fundamentals or external forces.
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 6/30/17, Zebra Technologies Corp. constituted 4.8% of Ariel Fund; JLL 4.0%; Bristow Group Inc. 1.2%; Viacom, Inc. 2.7% and Nielsen Holdings Plc 1.6%. 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 Fund.
The Russell 2500™ Value Index measures the performance of the small to mid-cap value segment of the U.S. equity universe. It includes those Russell 2500 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2500™ Index measures the performance of the small to mid - cap segment of the U.S. equity universe, commonly referred to as “smid” cap. The Russell 2500 Index is a subset of the Russell 3000® Index. It includes approximately 2,500 of the smallest securities based on a combination of their market cap and current index membership. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes or underlying data and no party may rely on any Russell Indexes and/or underlying data contained in this communication. No further distribution of Russell data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The S&P 500® Index is the most widely accepted barometer of large cap U.S. equities. It includes 500 leading companies.
Investing in small- and mid-cap stocks is riskier and more volatile than investing in large-cap stocks. The intrinsic value of the stocks in which the Fund invests may never be recognized by the broader market. Ariel Fund often invests a significant portion of its assets in companies within the financial services and consumer discretionary sectors, and its performance may suffer if these sectors underperform the overall stock market.
Performance data quoted represents past performance. Past performance does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains, and represents returns of the Investor Class shares. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. For the period ended June 30, 2017, the average annual total returns of Ariel Fund (Investor Class) for the 1-, 5- and 10-year periods were +26.10%, +16.06% and +6.57%, respectively. For the year ended September 30, 2016, the Fund’s Investor Class shares had an annual expense ratio of 1.02%. Performance data current to the most recent month-end for Ariel Fund may be obtained by visiting our website, arielinvestments.com.
