Oak Value Fund Managers Comment on Top Holdings: Berkshire Hathaway, Praxair, Coach, Avon Products, Aflac

We have learned that the odds of our success as long-term investors are much improved when we focus our attention on identifying and analyzing a select subset of such advantaged businesses and then patiently wait for the market to give us opportunities to buy them at attractive prices. Among the habits that have proven to be most crucial to our successful management of the Fund are: the establishment of an investable universe of advantaged businesses; the process by which we attempt to understand and analyze these businesses; the framework by which we assess their business models from a competitive, structural and economic standpoint; and, the manner in which we attempt to deliberately balance risk and reward opportunities within the context of a relatively concentrated portfolio.

Berkshire Hathaway – Shares of Berkshire Hathaway advanced nearly 23% during the quarter as thecompany completed its $44B acquisition of Burlington Northern and executed a 50-to-1 split of its class B shares. While the Burlington purchase was clearly significant and perhaps transformational, it was the combination of the stock split and the announcement that Standard and Poor’s would add Berkshire to the S&P 500 Index that claimed the spotlight during the period. Meanwhile, Berkshire reported a 19% gain in book value per share for 2009, quite an accomplishment amid a weak if improving economic backdrop. We believe Berkshire will continue to generate healthy returns for many years, even though its sheer size and cash-generating power will continue to create the high-class problem of having to find acceptable rates of return for all this capital. Interestingly, it could be argued that the company is beginning to look more like the industrial firm that it was in its early days. Our view is that the combination of Berkshire’s exceptionally well-run insurance business and the operational leverage inherent in Berkshire’s other businesses continues to represent economic advantages that should continue to create increased shareholder value over time. We incrementally reduced the Fund’s Berkshire position during the quarter as the shares advanced. A reduced margin of safety (in our opinion) compelled us to trim the position.


Praxair – Though Praxair shares declined modestly during the quarter, its management seems to have a habit of managing the business most effectively while investing deliberately and opportunistically to fuel future, profitable growth. We believe Praxair will continue to create value for shareholders as the global economy continues its nascent recovery. The measures that Praxair took to enhance productivity and profitability during the downturn will become apparent as global demand for industrial gases returns to a more normalized trajectory. During 2009, likely the cyclical trough for Praxair’s business, revenue declined 17% but earnings declined only 5%. That is the kind of resilience we like. Meanwhile, the company’s backlog of new business projects continued to expand throughout the year as Praxair further solidified its already market leading position in specialty natural gasses, particularly in emerging economies. Praxair’s capital investments are focused in the growth markets of India, Brazil, China and Mexico where the company already generates more than one third of its revenues. With pricing power intact, a substantial backlog of new contracts in place, and with operational leverage around the corner, we believe that Praxair shareholders will be rewarded with substantially higher economic returns.


Coach – Coach shares rose 8% during the first quarter, continuing to outperform the broader markets. The company continues to navigate extremely challenging economic conditions in a marketplace that is dependent on discretionary consumer spending. By managing price points and inventories and carefully balancing product availability between its full-price stores and its outlet stores, Coach has been able to preserve profitability. The Poppy and Madison lines, which sustained Coach’s revenues during the downturn and currently account for nearly half of full-price store revenue, are expected to continue to play an important strategic role for Coach. In our opinion, this company still has substantial growth potential as its brand is gaining real traction in new markets such as China where demand for foreign luxury brands appears insatiable and where the Coach brand is under-penetrated. The company’s strong balance sheet served shareholders well during the last two years and we expect that it will continue to do so as the company has recently increased its share repurchase program and initiated a quarterly cash dividend. Our view is that with margin recovery, ample growth opportunities ahead and lots of cash, Coach’s business is poised to continue to perform exceptionally well. In the category of habits, Coach has some pretty good ones.


Avon Products – Avon shares rose more than 8% during the quarter as the company did what many beauty companies could not do in 2009—it moved from a defensive position to an offensive one. The company used this period to focus on lower-price-point entry products while maintaining the integrity of its core products and offerings. Building on the success of this strategy, the company moved aggressively to grow the number of active representatives throughout its distribution network while continuing to focus on quality representation for its products. This expanded base of active representatives should provide a solid base for growth in 2010 and beyond. Avon has transformed its business in recent years as it has improved its product positioning, simplified its product portfolio, and sharpened its focus on technologically differentiated beauty products aimed at increasing representative productivity and gaining market share. Meanwhile, ongoing cost controls for central overhead expenses and improved supply chain management should create additional operational leverage for the business. Our investment thesis for this company is based on a continued multiyear expansion in operating margins and return on equity as the company more fully leverages its global platform.


Aflac – Aflac shares advanced 18% during the quarter. Despite a difficult economy in Japan - Aflac’s most important market - the company continues to drive new policy sales through effective marketing, successful product development, and efficient distribution. Improvements in the company’s loss ratio continue to boost profitability. The company's policies have proven to be far more profitable than was thought when they were written, and new policies also have attractive profit margins. Meanwhile, as the health care system in the U.S. evolves, we are confident that fundamental demand for low-premium supplemental insurance will increase in this market. The company’s recent foray into the domestic group sales channel suggests a new commitment to increasing penetration in the U.S. market. Like many insurance companies, Aflac experienced significant stress in its investment portfolio during the tumult affecting the global banking system. As a business that requires long-dated assets to match its long-dated liabilities, Aflac had gradually accumulated considerable investments in fixed income securities of financial institutions, including some exposure to certain European institutions via securities known as perpetual hybrids. Until the near-collapse of the global financial system, these securities were seen as extremely safe. As the seriousness of the problems facing certain banks became more evident, market prices for these securities plummeted and there was considerable speculation that Aflac might have to raise additional capital to offset what could have been sizable investment losses. While we make no claim to be an authority on European perpetual hybrid securities, our decision to stay with this long-term holding was based on the company’s demonstrated track record of high operating profitability and its ability to regenerate substantial capital even if sizable non-temporary losses in the investment portfolio were to occur. As the market’s perception of the potential losses from Aflac’s investment portfolio evolved to a more stable and less risky outlook, expectations for crippling investment losses dissipated and the stock has recovered significantly.