Despite continued, solid growth of the U.S. economy, equity markets ended 2018 poorly with the broad-market Russell 3000 Index dropping 14.30% during the last three months of the year. Sentiment turned sharply negative as investors became increasingly nervous about the negative impact of trade wars, the U.S. Government shutdown and growing political gridlock on further economic expansion. Investor over-reactions to both negative and positive news triggered a sharp increase in market volatility that continued into the New Year.
We believe that our long-term success has been determined by our long-term decision making when either extreme negative or positive sentiment overwhelms rational thinking. At such times, we generally see a growing disconnect between stock prices and our estimates of the intrinsic value of individual businesses. For us, selectivity and highly focused company-specific analysis become even more important factors for succeeding over long periods of time in a tough market environment, especially when there is a growing disconnect between stock prices and the intrinsic value of individual businesses. We believe it is important to withstand periods of short-term market volatility and negativity by favoring the equities of financially strong companies with stable or growing free cash flow that, in our opinion, are not properly valued by the market as a result of temporary problems and/or extreme negative short-term thinking. We require companies purchased for the portfolio to be run by managements that have a demonstrated history of deploying cash to the benefit of shareholders. As long-term value investors, our most important rule is to take advantage of market conditions and downward price movements to buy such companies at what we believe are advantageous prices. Paying the right price is our number one defense against portfolio risk.
O U R S T R A T E G Y
Our current portfolio consists of companies that we believe have sustainable competitive advantages, discernible balance sheet strength, management teams that emphasize decisions based on cost of capital calculations, deploy free cash flow to create shareholder value and sell at market prices that do not recognize our estimate of the company’s long-term intrinsic value. Our calculation of intrinsic value is based on our estimate of a company’s long-term ability to generate and/or grow normalized free cash flow. Before valuing a company, we carefully analyze the factors creating market discounts, and determine whether we believe the issues are of a short-term nature having little to do with long-term valuations. We remain focused on individual companies, their operations and prospects for maintaining or growing sustainable free cash flow since, from our perspective as long-term value investors, we recognize that companies generating growing sustainable free cash flow are well positioned to compete more profitably during both favorable and turbulent economic environments. We continue to seek and invest in companies that we believe have an ability to deliver long-term value to their shareholders that, in many cases, is not currently recognized by the market.
As 2019 unfolds we will continue to focus on those companies that demonstrate a commitment to maintaining a strong financial position; have the ability to generate As 2019 unfolds we will continue to focus on those companies that demonstrate a commitment to maintaining a strong financial position; have the ability to generate sustainable free cash flow; and are led by management teams that intelligently deploy cash in efforts to increase returns to shareholders. Remaining true to our investment discipline, we will seek to buy such companies at a significant discount to our determination of their intrinsic value based on long-term free cash flow metrics, and intend to seize on market dips as buying opportunities to either strategically add to existing positions in the portfolio or initiate positions in companies with these essential characteristics.
P O R T F O L I O R E V I E W
At December 31, 2018, the Olstein All Cap Value Fund portfolio consisted of 96 holdings with an average weighted market capitalization of $90.49 billion. During the six-month reporting period, the Fund initiated positions in eight companies and strategically added to positions in fifteen companies. Over the same time period, the Fund eliminated its holdings in eleven companies and strategically decreased its holdings in another sixteen companies. Positions initiated during the reporting period include: Cracker Barrel Old Country Store, Inc., Cummins Inc., Equifax, Inc., McDonald’s Corporation, Mohawk Industries, Inc., Packaging Corporation of America, S&P Global, and Starbucks Corporation. Positions eliminated during the past six months include: CommScope Holding Company, Inc., Conduent, Inc., Coty Inc., Henry Schein, Inc., Hormel Foods Corporation, Intuitive Surgical, Inc., Kimberly-Clark Corporation, PepsiCo, Inc., The Procter & Gamble Company, Spirit Airlines, Inc. and Stericycle, Inc.
The Fund sold its holdings in Henry Schein, Hormel Foods, Intuitive Surgical, Kimberly-Clark, PepsiCo, and Procter & Gamble during the reporting period as the stock price of each of these companies reached our value. Similarly, as the company’s stock price moved closer to our valuation, the Fund liquidated its position in Spirit Airlines to reduce the portfolio’s overall exposure to the airline industry. The Fund liquidated its positions in Conduent and Stericycle as management at both companies attempted to reset expectations for their respective operational turnarounds. In both cases, extending the time line for achieving desired results invalidated our original investment thesis.
The Fund liquidated its holding in CommScope (COMM, Financial) following the company’s announcement that it would acquire ARRIS International (ARRS, Financial). We believe such an acquisition is not in shareholders’ best interest, and will force the company to shift away from improving its core operations to focus instead on the post-acquisition issues. The Fund also liquidated its holding in Coty Inc. (COTY, Financial), as the company suffered from sluggish sales due to stiff competition in the mass-market beauty segment. The brand’s worse-than-expected results led us to question the expected duration of Coty’s turnaround efforts.
Our Leaders
The holdings which contributed positively to performance for the six-month reporting period include: Spirit Airlines, Starbucks Corporation, Casey’s General Stores, Inc., Henry Schein Inc., and The Procter & Gamble Company. At the close of the reporting period on December 31, 2018 the Fund continued to hold Starbucks, and Casey’s General Stores in its portfolio. During the reporting period the Fund liquidated its holdings in Spirit Airlines, Henry Schein and Procter & Gamble.
Our Laggards
Laggards during the six-month reporting period include: Delphi Technologies, Western Digital Corp., Mohawk Industries, Coty, Inc. and Invesco Ltd. At the close of the reporting period the Fund continued to hold Delphi Technologies, Western Digital Corp., Mohawk Industries and Invesco Ltd. During the reporting period the Fund liquidated its holdings in Coty, Inc. In light of stiff competition in the mass-market beauty segment and recent sluggish sales, we determined that the company’s turnaround strategy would take longer that our original thesis anticipated.
F I N A L T H O U G H T S
Bouts of market volatility are an unsettling, but normal, feature of long-term investing. During such times, our investment principles do not change – we believe that analysis of specific companies, their potential, prospects and value, and not overall market sentiment, are the keys to making decisions that increase the chance for successful investment outcomes. Since we believe that effectively timing the market’s ups and downs is nearly impossible, we intend to stay focused on the long-term by identifying opportunities for meaningful capital appreciation presented by individual companies, and by exploiting market drops and dips to strategically add to existing positions in the portfolio or initiate positions in companies that possess our essential value characteristics. We act exactly opposite by selling fully valued and/or avoiding overvalued securities during times when positive market sentiment overwhelms rational thinking. We are always willing to hold or raise cash when there is a lack of undervalued investment opportunities.
We value your trust and remind you that our money is invested alongside yours as we work hard to accomplish the Fund’s primary objective of long-term capital appreciation employing our “looking behind the numbers” free cash flow based investment discipline. We look forward to writing to you again at the close of the Fund’s fiscal year.
Sincerely,
Robert A. Olstein Eric R. Heyman
Chairman and Chief Investment Officer Co-Portfolio Manager
The above represents opinion, and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. The references to securities are not buy or sell recommendations, but are intended to be descriptive examples of the Fund’s investment philosophy and are subject to change. Do not make investments based on the securities referenced. A full schedule of fund holdings as of 12/31/18 is contained in this report, and is subject to change. This information should be preceded or accompanied by a current prospectus, which contains more complete information, including investment objectives, risks, charges and expenses of the Olstein Funds and should be read carefully before investing. A current prospectus may be obtained by calling (800) 799-2113 or visiting the Olstein Funds’ website at www.olsteinfunds.com.
The Olstein Funds follow a value-oriented investment approach. However, a particular value stock may not increase in price as the Investment Manager anticipates and may actually decline in price if other investors fail to recognize the stock’s value or if a catalyst that the Investment Manager believes will increase the price of the stock does not occur or does not affect the price of the stock in the manner or to the degree that the Investment Manager anticipated. Also, the Investment Manager’s calculation of a stock’s private market value involves estimates of future cash flow which may prove to be incorrect and, therefore, could result in sales of the stock at prices lower than the Fund’s original purchase price. There is no assurance that the Fund will achieve its investment objective.
