Ron Baron, CIO and Portfolio Manager: On Investment Strategy and Current Investment Outlook (Page 3).
We remain committed to a “plain vanilla” strategy of investing for the long term in people who run businesses that we think have an opportunity to become much larger than they are at present.
We believe that the next several years offer better opportunities for stock pickers than have been available for many years.
Healthcare, education, infrastructure, domestic energy, consumer staples, business services, financial services and government services are among the areas where we currently find attractive investment opportunities. Many of these industries will benefit from government initiatives already in place.
We expect many of the financially strong businesses in which we have invested to earn more in 2009 than 2008 despite the difficult economic environment.
Linda Martinson, President and COO: On Needs to Be Selective Going Forward (Page 5)
With most sectors of the economy bouncing back, it was not hard to find companies that posted strong gains. After a market decline in excess of 50%, almost everything was undervalued. In fact, some of the stocks and sectors that had performed the worst over the past year gained the most in the past quarter.
Looking ahead, however, we think the market will be much more selective. We believe that stocks are more fairly valued now than they were at the end of March. So we think that investors will need to be more discriminating to take advantage of an economic recovery. To be successful, we think investors will need to seek out those companies that are likely to achieve the highest growth rates going forward.
Comments on Individual Stocks
Here are comments on some stocks that Ron Baron and his fund managers and analysts gave in the report:
Wynn Resorts, Ltd. (WYNN)
Wynn Resorts’ shares rose on increased investor optimism that the ongoing declines in visitation at its Las Vegas properties had bottomed, implying that operating results in that market may not fall any further. In addition, during April, the company’s booking window increased slightly as customers took advantage of promotional deals and booked rooms earlier to qualify for promotional rates. This helped the company to better manage its yield, resulting in improved revenue per available room during the quarter. As a result, since the end of the first quarter, occupancy levels at its Las Vegas properties increased from the 80%-range to the 90%-range, even with the much larger room count that resulted from the opening of its Encore Las Vegas property in December 2008. We believe that Wynn has also done a fine job cutting its overhead costs to reflect its lower current level of revenues, and we believe that this should improve its ongoing results. In addition, the company improved the strength of its balance sheet during the quarter by extending $900 million of its $1.3 billion in debt maturing over the next two years, while also achieving relaxation of covenants on that debt. The company also completed an equity offering in March. We believe that Wynn’s improved balance sheet has placed the company in a stronger financial position than nearly all its competitors, affording Wynn greater flexibility to reinvest in its existing properties and to take advantage of any asset acquisition opportunities that may arise from its competitors’ distress. (David Baron)
C.H. Robinson Worldwide, Inc (CHRW)
Shares of C.H. Robinson , the nation’s leading truck broker, advanced after it reported an impressive increase in earnings despite the extremely challenging environment for U.S. freight. We believe that the company’s ability to generate growth during a recession is testament to its superior business model, which employs no hard assets (trucks) and features automatic cost stabilizers in the form of incentive-based pay programs that ratchet down as revenue slows. As a pure transportation broker, the company uses a sophisticated technology platform to match shipping customer loads with available transportation capacity in return for a fee. While the current environment for loads is weak (the demand side), available truck capacity (the supply side) is relatively abundant, as carriers have staved off bankruptcy with help from fuel’s rapid decline and leniency on the part of lenders uninterested in owning trucks as collateral. This current oversupply of trucks enables Robinson to buy capacity in the spot market at cheaper rates, boosting the company’s gross profits and bottom line. Should demand improve into an economic recovery and capacity tighten, we believe the company will still be able to generate solid earnings growth through revenue gains as opposed to lower cost of goods. Meanwhile, the company has continued to build cash, now at almost $400 million, which they have been using to repurchase stock, increase its dividend and make selective acquisitions. At a time when industry truckload volumes are down 15-20% and its public carrier peers are reporting double-digit drops in profitability, we believe that Robinson’s ability to grow through the cycle stands out as a significant accomplishment. (Matt Weiss)
Alexander’s Inc. (ALX)
Alexander’s share price rose meaningfully during the quarter, outperforming both the REIT index and the broader market. The stock had fallen significantly earlier this year on what we believe to have been overblown concerns about deteriorating New York commercial real estate fundamentals (rising vacancies and falling rents), the seizing up of the credit markets, and an expectation for industrywide distressed real estate sales. We believe that Alexander’s operates one of the highest-quality real estate portfolios with the Bloomberg Tower as its trophy asset. Further, with more than $400 million of cash on its balance sheet (more than $80/share), we believe Alexander’s has sufficient liquidity to meet all of its debt obligations for the next five years and perhaps to capitalize on future distress in the commercial real estate markets. (Jeff Kolitch)
IDEXX Laboratories (IDXX)
IDEXX Laboratories’ shares performed well during the second quarter, helped by better-than-expected first quarter earnings, intact 2009 earnings guidance, and some indications that foot traffic trends in veterinary clinics may have bottomed. Although the recession has dampened its growth, the company’s revenue has continued to accelerate, helped by expanded market share for its veterinary machines, increased pet ownership, and new product launches like the CatalystDX, the company’s next-generation blood chemistry analyzer. We believe that the CatalystDX represents a substantial improvement in technology over existing products, and we believe that it should contribute meaningfully to the company’s future profitability. In its laboratory testing unit, IDEXX recently launched its proprietary Cardiopet proBNP test, designed to detect cardiac disease in dogs and cats by testing for a biomarker released by the heart. This represents a novel way to test for cardiac disease in pets, and we expect strong adoption by veterinarians who can provide better care to their patients by using this diagnostic test. While it is still too early to call a clear improvement in veterinary industry fundamentals, we believe that veterinary visits will be an early beneficiary of an economic recovery, as pet owners need to have their animals thoroughly examined after deferring recent visits or procedures. (Neal Rosenberg)
XTO Energy (XTO)
XTO Energy’s shares rose even though natural gas prices were essentially flat during the quarter, as concerns mounted throughout the period about the near-to-medium term outlook for gas prices amid declining demand and rising supply. Even though XTO remains primarily a natural gas producer, several recent acquisitions have increased the company’s exposure to crude oil production, which appeared to benefit the share price (in contrast to gas, oil prices rose approximately 40% during the quarter). In addition, as concerns over the near-term outlook for gas increased, we believe that investors began to recognize the value of XTO management’s decision in the second half of 2008 to aggressively hedge its production for 2009 and part of 2010, thereby protecting cash flow and enabling the company to maintain its capital spending outlook, while still generating free cash flow that can be used for debt reduction. We believe that an important strength of XTO has been its ability to acquire properties and then enhance their value through its expertise in resource exploitation. This expertise, coupled with a conservative financial model that has sought to manage its production growth at a sustainable long-term rate at a level below its annual cash flow, allowed XTO to grow while generating premium returns on invested capital. With its inventory restocked from last year’s series of acquisitions and its cash flow protected by hedges, XTO has refocused on its historical core strategy of enhancing value through drilling and wisely deploying capital. It appears that investors gravitated to XTO in recognition that: i) the company would not make acquisitions in the near-term; ii) XTO’s strong hedge position increased in value due to weakness in spot gas prices; and, iii) its free cash flow for 2009 and 2010 puts XTO in a strong position, as some of its peers began to struggle with their 2010 growth outlooks due to lack of adequate gross and free cash flow. We continue to view XTO as one of the best-run companies in its industry with a management team that has consistently and successfully followed its core strategy. Furthermore, we believe that its 2008 acquisitions will give XTO a strong position in many of the country’s key emerging oil and natural gas regions for the next five to ten years. (Jamie Stone)