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John Rogers of Ariel Funds Likes Covidien plc, Newell Rubbermaid Inc., Viacom Inc.

December 17, 2009 | About:

Ariel Funds, run by John Rogers, emphasizes deep value philosophy in their stock picking. The prefer companies with steady growth, sold at a discount to the intrinsic values they assign to. These are portfolio spotlight on three of their holdings.

Covidien plc (COV)

Covidien PLC, formerly Covidien Ltd, is engaged in the development, manufacture and sale of healthcare products for use in clinical and home settings. It operates its business through four segments: Medical Devices, Imaging Solutions, Pharmaceutical Products and Medical Supplies. The Medical Devices segment includes the development, manufacture and sale of endomechanical, soft tissue repair, energy, oximetry and monitoring, airway and ventilation, vascular, SharpSafety and clinical care products; Imaging Solutions, which includes the development, manufacture and marketing of radiopharmaceuticals and contrast products; Pharmaceutical Products, which includes the development, manufacture and distribution of dosage pharmaceuticals and active pharmaceutical ingredients, and Medical Supplies, which includes the development, manufacture and sale of nursing care products, medical surgical products and original equipment manufacturer products. Covidien Ltd. has a market cap of $23.34 billion; its shares were traded at around $46.74 with a P/E ratio of 16.1 and P/S ratio of 2.2. The dividend yield of Covidien Ltd. stocks is 1.5%.

This is the analysis of Ariel Funds on Covidien:

Active Management

Under the former Tyco International Ltd. (TYC), Covidien operated with an extremely diverse product portfolio ranging from the highly-technical hospital surgical products to the commodity-like incontinence products sold in a retail pharmacy. After its spin-off from Tyco in 2007, its management team has aggressively managed its portfolio of products to remain diversified yet focused on complimentary core technologies that provide the opportunity for higher long-term growth and profits. Over the past two years, Covidien has sold all of its retail business and some other products, such as some medical supplies, that do not have a strong growth and profitability. Management wants future acquisitions to enhance and supplement its internal research and development initiatives, thereby extending core product opportunities.

Focus On Innovation

The company underinvested in research and development for several years under Tyco. However, in the years leading up to its spin-off, management increased its focus on research and development to strengthen innovation and broaden its product portfolio. Since emerging as a standalone public company, management has emphasized innovation by creating an infrastructure to encourage development and increase productivity. The company has grown its R&D spending from $274 million in 2007 to an estimated $400 million this year. The company is already reaping rewards through a solid, robust pipeline of products and with a host of recent FDA and global approvals. To that end, Covidien was recognized as the top innovator for intellectual property quality and quantity in the medical devices and services industry by The Patent Board™, which is the patent ratings partner of The Wall Street Journal.

Health Care Reform Fears

Nearly all Americans believe health care costs in the United States are advancing at unsustainable rates. As we write, Congress and the Senate are attempting to bring a bi-partisan bill together to decrease the number of uninsured Americans and temper health care inflation. Because many of Covidien’s products allow for minimally invasive procedures, it is poised to benefit from some aspects of health care reform. Procedures, such as laparoscopic gastric banding, allow a patient to recover faster, have smaller and fewer incisions, lower operating room times, and decrease the length of stays sometimes to zero. All of these factors will help decrease the growth rate of health care costs in the future.

We believe Wall Street has overblown the impact of health care reform on Covidien and is providing little credit to its full pipeline of products set to launch over the next several years. As of September 30, 2009, shares traded at $43.26, a 30% discount to our private market value of $62.11.

Gurus' Positions with COV

Covidien Ltd. is owned by 10 Gurus. George Soros bought 12,800 shares in the quarter that ended on 09/30/2009, which is 0.01% of the $4.41 billion portfolio of Soros Fund Management LLC.

Private Capital owns 823,890 shares as of 09/30/2009, an increase of 29.43% from the previous quarter. This position accounts for 2.27% of the $1.57 billion portfolio of Private Capital Management. Edward Owens owns 1,150,000 shares as of 09/30/2009, an increase of 15% from the previous quarter. This position accounts for 0.27% of the $18.2 billion portfolio of Vanguard Health Care Fund.

7 other Gurus Kept Positions in COV Unchanged or Slightly Adjusted; 1 Guru Reduced Positions in COV

Newell Rubbermaid Inc. (NWL)

Newell Rubbermaid, Inc. is a global manufacturer and full-service marketer of name-brand consumer products serving the needs of volume purchasers,including discount stores and warehouse clubs, home centers and hardware stores, and office superstores and contract stationers. The company's multi-product offering consists of name-brand consumer products in six business segments: Storage, Organization & Cleaning; Home Decor; Office Products; Infant/Juvenile Care & Play; Food Preparation, Cooking & Serving and Hardware & Tools. Newell Rubbermaid Inc. has a market cap of $4.12 billion; its shares were traded at around $14.82 with a P/E ratio of 12.8 and P/S ratio of 0.7. The dividend yield of Newell Rubbermaid Inc. stocks is 1.3%. Newell Rubbermaid Inc. had an annual average earning growth of 4.1% over the past 5 years.

Analysis of NWL by Ariel Funds:

A New Newell

Over the past five years, Newell Rubbermaid’s management has transformed it into a great company focused on great brands. In 2003, 44% of the company’s sales were in commoditized categories, versus only 4% today. The company has exited lackluster categories and sold ho-hum product lines. In the past year, the company has shored up its balance sheet to ensure it is well-financed for years to come.

Brands That Matter

Newell Rubbermaid delivers global consumers trusted brands whose reputations have been built over generations. Parents, who will not settle for anything but the best, trust Graco® car seats to protect their children. Contractors count on Unibit® drill bits to get the job done. There is no replacement for a Sharpie® in the office. Calphalon® cookware brings professional cooking home, while Goody® barrettes are holding millions of hairdos in place.

Attention to Costs

Raw material costs soared in the commodity bubble of 2007 and 2008, crimping Newell Rubbermaid’s margins. In response, management took the necessary actions to maintain profits. It aggressively took costs out of the company by reducing resin-based commodity products. In fact, management has closed 40% of its plants since 2006. Big shifts like that are unusual but critical in making a company leaner yet stronger. Before this shift, there was cause for concern that raw material inflation could reduce margins; now we are pleased to see the strength of its brands providing healthy growth. These transformational steps have depressed margins for several years, but now the heavy lifting has been done. We think margins will expand quickly as management’s improvements take hold, and shareholder returns will follow.

Positioned for the future

Investors are still treating Newell Rubbermaid like the company it was five years ago. They have not yet taken into account the improved product positioning and stronger balance sheet. In the depths of the market downturn, investors feared the company’s categories would shrink indefinitely. But people will not accept second best car seats, pens or cookware. As credit markets froze, investors feared the company’s balance sheet would buckle under pressure. We knew the products would remain relevant and the balance sheet was sound, so we held on tight.

As of September 30, 2009, Newell Rubbermaid traded at $15.69, a 9% discount to our private market value of $17.16.

Newell Rubbermaid Inc. is owned by 6 Gurus. They all kept positions in NWL unchanged or slightly adjusted.

Viacom Inc.,

Viacom is a leading global entertainment content company whose family of prominent and respected brands includes the multiplatform properties of MTV Networks, BET Networks, Paramount Pictures, Paramount Home Entertainment and DreamWorks. MTV Networks, a unit of Viacom, is one of the world's leading creators of programming and content across all media platforms. MTV Networks connects with its audiences through its robust consumer products businesses and its more than three hundred interactive properties worldwide, including online, broadband, wireless and interactive television services and also has licensing agreements, joint ventures, and syndication deals whereby all of its programming services can be seen worldwide. Viacom Inc. has a market cap of $16.93 billion; its shares were traded at around $30.53 with a P/E ratio of 12.8 and P/S ratio of 1.2.

Major Entertainment Brands

Viacom focuses on valuable media franchises with niches that allow it to grab and hold a big market share. For example, parents trust Nickelodeon to deliver safe content to their children, and kids love the characters, from Dora the Explorer to The Fairly OddParents. Together, they’ve made Nickelodeon the most watched cable network in the U.S. Nickelodeon has created franchises like SpongeBob SquarePants, which transcend television to appear in movies, video games, toys, apparel and theme park rides. COMEDY CENTRAL has built a unique brand as the only network dedicated to comedy. When people want to laugh, they know they can tune in to COMEDY CENTRAL any time of day. Additionally, Viacom has a growing business selling video games and licensing its brands. For example, The Beatles: Rock Band, the newest addition to an expanding video game franchise, was one of the most anticipated video game releases of the year, selling nearly 600,000 copies.

Growth with Stability

The media networks’ dual-revenue stream business model offers attractive economics throughout any part of a business cycle. During a recession, affiliate fees—paid by cable providers to cable networks—provide growing income since consumers are loath to cancel their cable subscriptions. When the economy is humming, advertising revenue expands as companies seek to reach the valuable demographics Viacom delivers. The current economic recovery is a perfect opportunity to take advantage of this growth.

Playing the Right Tune

Investors focus on the most visible pieces of the business even if these do not generate the largest portion of profits. For several years, investors have worried that MTV has lost its way as the MTV Generation has grown up. With MTV representing only 13% of our estimate of the company’s value, we believe investors are overly focused on the turnaround of this fragment of the company. Given the current pessimism about MTV, any success by management will exceed investor expectations. The filmed entertainment business also receives a disproportionate amount of attention. Although the business generates 40% of the company’s revenues, it generates only 4% of profits because of its low margins. Investors focus on the near-term headwinds of declining DVD sales and a crowded film production industry, because the output of this segment—glamorous movies—is very visible, even though not highly profitable.

We initiated our position in mid-July at $20.83. Despite the stock’s increase, we believe the stock still has substantial upside opportunity. As of September 30, 2009, shares traded at $28.04, a 22% discount to our private market value of $35.76.

Viacom Inc. is owned by 9 Gurus. John Rogers bought 1,472,320 shares in the quarter that ended on 09/30/2009, which is 0.91% of the $4.51 billion portfolio of ARIEL CAPITAL MANAGEMENT LLC. 7 Gurus kept positions in VIA-B unchanged or slightly adjusted; Richard Pzena sold out his holdings in the quarter that ended on 09/30/2009.


Rating: 3.3/5 (4 votes)

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