To Our Shareholders,
For the quarter ended December 31, 2019, the net asset value (NAV) per Class A Share of The Gabelli Value 25 Fund increased 6.5% compared with increases of 9.1% and 6.7% for the Standard & Poor’s (S&P) 500 Index and the Dow Jones Industrial Average, respectively. Other classes of shares are available. See page 2 for additional performance information for all classes.
Introduction: Starting the 20s With a Roar1
In absolute terms, 2019 was an excellent year with stocks, corporate bonds, gold and oil all up double digits. This contrasted sharply with 2018 when virtually every asset class declined as a result of a growth scare reminiscent of those in 2011 and 2015. Economic growth in the U.S. indeed slowed but remained above 2%. As it turns out, the 2010s was the first decade in U.S. history without a recession and home to the longest bull market on record. Life in the political realm has remained more volatile. While Brexit and U.S. trade deals appear on a path to resolution, President Trump faces impeachment and the coming election is sure to keep 2020 interesting. From here, the economy and the markets figure to grind higher, albeit the latter at a muted pace.
Like the Roaring 1920s, we see the coming decade marked by the mass adoption of new technologies (e.g. artificial intelligence) and great societal change, in this case a focus on the environment in what we have called the Decade of the Planet. We are also seeing signs of a shift in the prevailing investment regime to one that favors our value-oriented Private Market Value with a CatalystTM approach. Regardless of the macro events unfolding, we remain committed to our process and methodology and are excited about the opportunities ahead of us.
Barron’s 2020 Roundtable
Mario J. Gabelli, our Chief Investment Officer, has appeared in the prestigious Barron’s Roundtable discussion annually since 1980. Many of our readers enjoyed the inclusion of selected and edited comments from Barron’s Roundtable in previous reports to shareholders. As is our custom, we are including selected comments of Mario Gabelli (Trades, Portfolio) from Barron’s, published on January 27, 2020.
View excerpt here.
Politics, Economics & The Market
Much as a blinding snowstorm can give way to a crystalline paradise, the tumult of late 2018 created a wonderland of bargains in the market. In retrospect it appears investors correctly anticipated an economic slowdown that manifested itself primarily in the industrial and materials sectors (key purchasing manager indices spent the last three quarters of 2019 in contraction) and flat corporate earnings in 2019. However, the markets, ever forward looking, rebounded as the so-called Powell and Trump puts were triggered. Federal Reserve Chairman Jerome Powell backtracked on his project to normalize interest rates, cutting rates three times and increasing bond purchases and overnight funding operations. After escalating trade hostilities with China, President Trump showed an increasing willingness to make amends, culminating in Phase One of a deal announced, but not signed, in December. All the while, the American consumer has remained steadfast, supported by the lowest unemployment rate (3.6%) since 1969 and rising household wealth (+3% to $114 trillion).
The 2019 manufacturing air pocket may be the pause that refreshes, extending the 126 month expansion, the longest on record. The strength, breadth and length of this expansion will clearly be influenced by a number of factors including the outcome of the 2020 presidential election and the many issues underpinning it – wealth inequality, educational and health care costs, trade policy and the national debt/deficit (we would prefer a bit more focus on the latter).
With a recession postponed yet again and interest rates lower, the total return of the S&P 500 exceeded 30% in 2019, propelled almost entirely by an expansion of the average earnings multiple from 15x to 19x. Earnings in 2020 should benefit from accelerating economic activity and an easier comparison versus 2019. At first blush it may be difficult to believe multiples could expand or even remain flat from here, especially with the looming election, but considering that 2019 included Brexit, impeachment, trade crises and unrest in Hong Kong among other issues, it becomes less of leap of faith. Unforeseen events are sure to emerge in the new year, but the market is likely just as apt to continue treating them as noise.
The Great Rotation?
Equity returns in 2019 were by no means smooth. The market recovered its September 2018 highs in April and traded sideways until the late summer. The first nine months of 2019 followed the script of nine of the last ten years. That is, the most expensive stocks outperformed the cheapest stocks, or as popularly formulated, Growth beat Value. However, coinciding with the beginning of a year-end push higher, the second week of September saw an abrupt shift as some of the most adored stocks dramatically lagged the forgotten and forlorn stocks. Although Value ultimately lost again to Growth, it outperformed in fits and starts throughout the fourth quarter. Among the reasons: (a) market anticipation of an economic upturn in mid-2020 benefitting cyclical stocks, which are more often also value stocks; (b) a steepening of the yield curve, particularly benefitting financial stocks which comprise more than one quarter of most value indices; and (c) a gap in valuations between dear and cheap approaching historical extremes.
The Disrupted Disrupters
We would posit one other reason for confidence in a value comeback – the bursting of the late stage venture bubble in what might be called the “WeWork effect” after the $47 billion real estate unicorn that came crashing to earth. The share prices of a number of newly public unicorns such as Uber, Lyft, Slack, SmileDirectClub and Pinterest provide further evidence that something is amiss with the business model of giving services away in the hope of one day making money. A pivot to profitability for a number of venture funded companies should support the cash flow generative companies we tend to favor. Indeed, many industry incumbents – what we term the Disrupted Disrupters – are fighting back. Despite controlling the most valuable entertainment properties on earth, The Walt Disney Company (1.6% of net assets as of December 31, 2019) has faced headwinds from a pay-TV subscriber base eroded by the likes of Netflix and YouTube. In response, Disney has reclaimed much of its previously licensed content to launch its own direct-to-consumer experience, Disney+. Other traditional media companies are following similar paths. Similarly, Edgewell, (0.4%) owner of the Schick brand, agreed to purchase shaving upstart Harry’s to accelerate their efforts to reach younger consumers while Conagra and Maple Leaf Foods are investing in innovation, going beyond the burger with their own plant-based meat alternative.
2020s: The Decade of the Planet
The selection of sixteen year-old environmental activist Greta Thunberg as Time magazine’s Person of the Year may have been controversial, but it certainly captured the spirit of a period marked by the introduction of the Green New Deal and an inability to get a plastic straw at most dining establishments. Irrespective of how much the climate may actually be changing, how much influence humans have in it or what can or should be done to address it, global warming will animate our youth and the public policies they will increasingly control for the foreseeable future. Of course, the social consciousness reminiscent of the anti-war movement of the 1960s goes beyond just climate change. The World Wide Web (www.) defined much of the last 20+ years; three new W’s may define the coming decade:
Weather – Climate change and everything related to reducing greenhouse emissions, including renewable power generation, vehicle electrification, plant-based foods, and carbon sequestration.
Water – As demonstrated by recent issues in Flint and Newark, access to clean water is not just a Third World problem. Significant investment will be required for water conservation, sanitation and delivery globally.
Waste – Reduce, Reuse, Recycle are buzzwords that require broader adoption. Innovation in manufacturing and packaging are needed to reduce the human footprint on global ecosystems.
We have integrated the discussion of environmental impacts into our broader investment process. We seek to identify companies whose businesses might be threatened over a long time horizon by one the Ws (e.g. all aspects of the internal combustion engine, plastic production, etc.). Perhaps more importantly, we’re also looking for companies that can benefit from increased investment in addressing environmental issues and/or a shift in consumer preferences for such companies.
SRI and ESG
Not surprisingly, the environmental theme has drawn tremendous interest at our firm and other asset managers, with over $30 trillion currently invested in Environmental, Social, Governance (ESG) strategies globally. Socially conscious investing has seen several incarnations including the anti-apartheid Sullivan principles adopted in the late 1970s. Gabelli entered the Socially Responsive Investing (SRI) field in 1987 largely on behalf of religious institutions. SRI strategies typically exclude companies that participate in certain activities such as gambling, tobacco and weapons production. Separately, Gabelli formalized its focus on the corporate governance of all firms with our Magna Carta of Shareholder Rights published in 1988. ESG, which first appeared in the early 2000s, attempts to unite a focus on the environmental and societal impacts of a firm with its corporate governance. ESG strategies aren’t necessarily exclusionary (although the Gabelli ESG fund specifically prohibits investment in fossil fuels, gambling and weapons production); rather, ESG investors tend to emphasize companies that at a minimum do no harm and at best make positive contributions to the issues that matter to them. While ESG strategies encompass many of the governance principles outlined in our Magna Carta, governance becomes especially relevant to the extent it reinforces good environmental and social practices. Finally, Impact Investing goes beyond SRI and ESG investing in that it is usually focused on a narrower set of issues and may often prioritize advancement of those issues ahead of short and medium term profitability. Over the long-run, the goal of most Impact Investors and some ESG investors is to lower the cost of capital for firms regarded as good actors by driving investment toward them.
Clearly this area is evolving quickly and requires the refinement of the definitions surrounding ESG as well as the techniques to measure firm compliance with those objectives. We think our accumulated compounded knowledge of industries uniquely positions us to evaluate the ESG quality of many companies while our history of bespoke investment strategies enables us to respond to growing client demand. Please contact us if you are interested in hearing more about these developments.
Investment Scorecard
With a preliminary resolution to trade issues and an accommodative Fed, industrial stocks rebounded strongly in 2019. Among the largest contributors to returns for the fourth quarter and the year were diversified industrial Honeywell (2.3% of net assets as of December 31, 2019, +38%) and pump and valve supplier Circor International (1.0%, +117). After some early year market trepidation over the coming video game cycle, Sony (7.3%, +42%) continued its resurgence as its music and media portfolios performed well the investors gained new appreciation for its investment in the next generation sensors integral to phones and vehicles. Supported by robust consumer spending, Mastercard (1.3%, +59%) and American Express (4.4%, +32%) reached new highs. Consumer stocks Swedish Match (4.8%, +34%) and global snack maker Mondelez (1.4%, +40%) added meaningfully to performance for the year with Swedish Match the fourth quarter leader after the FDA designated the company’s General snus products as less harmful than cigarettes, and the company continues to see strong growth for its ZYN nicotine pouches. Finally, with uncertainty elevated and loose monetary conditions, the Fund benefitted from its long-time position in leading gold miner Newmont Goldcorp (4.8%, +31%).
Despite strong performance from The Walt Disney Company (1.6%, +33%) and cable distributors Comcast (1.7%, +34%) and Liberty Broadband (1.0%, +75%) (the John Malone-related entity that owns 25% of Charter Communications), cable programming companies such as AMC Networks (0.9%, -28%), MSG Networks (0.8%, -26%) and ViacomCBS (11.2%, -4%) faced continued headwinds from a shift in consumer behavior away from the traditional pay-TV bundle. Notably, Viacom and CBS completed their long-discussed reunion during the year with that increased scale will assist them in addressing the changing landscape. Finally, Telephone & Data Systems (0.8%, -20%) and US Cellular (0.5%, -30%) retraced their 2018 gains as the wireless industry remains competitive and the company searches for strategic direction.
Let’s Talk Stocks
The following are stock specifics on selected holdings of our Fund. Favorable earnings prospects do not necessarily translate into higher stock prices, but they do express a positive trend that we believe will develop over time. Individual securities mentioned are not necessarily representative of the entire portfolio. For the following holdings, the share prices are listed first in United States dollars (USD) and second in the local currency, where applicable, and are presented as of December 31, 2019.
American Express Co. (AXP, Financial) (4.4%) (AXP – $124.49 – NYSE) is the largest closed loop credit card company in the world. The company operates its eponymous premiere branded payment network and lends to its largely affluent customer base. As of September 2019, American Express has 114 million cards in force and nearly $84 billion in loans, while its customers charged $1.2 trillion of spending on their cards in 2018. The company’s strong consumer brand has allowed American Express to enter the deposit gathering market as an alternate source of funding, while the company’s affluent customers have picked up spending. Longer term, American Express should capitalize on its higher spending customer base and continue to expand into other payment related businesses, such as corporate purchasing, while also growing in emerging markets. Similarly, the company is looking at the growing success of social media as an opportunity to expand its product base and payment options.
Bank of New York Mellon Corp. (BK, Financial) (3.2%) (BK – $50.33 – NYSE) is a global leader in providing financial services to institutions and individuals. The company operates in more than one hundred markets worldwide and strives to be the global provider of choice for investment management and investment services. As of December 2019, the firm had $37.1 trillion in assets under custody and $2.0 trillion in assets under management. Going forward, we expect BK to benefit from rising global incomes and the cross border movement of financial transactions.
Crane Co. (CR, Financial) (2.2%) (CR – $86.38 – NYSE), based in Stamford, Connecticut, is a diversified manufacturer of highly engineered industrial products comprised of four business segments: Fluid handling, Aerospace & Electronics, Engineered Materials, and Payments & Merchandising Systems with over 11,000 employees across 26 countries. The company recently acquired Crane Currency, a producer of currency products for more than 200 years and is entrusted by more than 50 central banks to play an integral role in the design and manufacture of their nations’ banknotes. Crane Currency is the fastest growing fully integrated global currency provider and is an excellent complement to Crane Co.’s expanding presence in the currency and payment markets.
Madison Square Garden Co. (MSG, Financial) (5.3%) (MSG – $294.19 – NYSE) is an integrated sports and entertainment company that owns the New York Knicks, the New York Rangers, the Radio City Christmas Spectacular, The Forum, and that iconic New York venue, Madison Square Garden. These evergreen content and venue assets benefit from sustainable barriers to entry and long term secular growth. MSG completed the separation of its associated regional sports networks in September 2015, leaving a reliable cash flow stream for MSG to reinvest and repurchase shares. The company reiterated its intent to separate into a Sports company (consisting of the teams) and an Entertainment company (consisting of MSG’s concert business, Christmas Spectacular, arenas and development assets including the Spheres in Las Vegas and London). Although delayed, we expect a transaction early in 2020.
Republic Services Inc. (RSG, Financial) (4.0%) (RSG – $89.63 – NYSE), based in Phoenix, Arizona, became the second largest solid waste company in North America after its acquisition of Allied Waste Industries in December 2008. Republic provides nonhazardous solid waste collection services for commercial, industrial, municipal, and residential customers in forty-one states and Puerto Rico. Republic serves more than 2,800 municipalities and operates 190 landfills, 211 transfer stations, 342 collection operations, and 88 recycling facilities. Since the Allied merger, Republic has benefited from synergies driven by route density, beneficial use of acquired assets, and reduction in redundant corporate overhead. Republic is committed to its core solid waste business. While other providers have strayed into alternative waste resource technologies and strategies, we view Republic’s plan to remain steadfast in the traditional solid waste business positively. We expect continued solid waste growth acquisitions, earnings improvement, and incremental route density and internalization growth in already established markets to generate real value in the near to medium term, highlighting the company’s potential.
Sony Corp. (SNE, Financial) (7.3%) (SNE – $68.00 – NYSE) is a conglomerate based in Tokyo, Japan, focusing on direct-to-consumer entertainment products supported by the company’s technology. Sony is the #1 integrated global gaming company and we expect the gaming segment to contribute over 1/3 of total EBITDA (ex-financial) in 2020 following the much anticipated launch of the PlayStation 5, probably for the 2020 holiday season. Sony Music Recording commands #2 and Music Publishing #1 global share. Sony also operates the Sony/Columbia film studio, which is well positioned in the OTT streaming wars as a major supplier of high quality library shows like Seinfeld and new movies like Once Upon a Time in Hollywood. It is an image sensor leader with over 50% global revenue share and is the dominant supplier to Apple iPhone. Sony’s Electronics business is a globally diversified cash cow. It also holds majority ownership of Sony Financial Services.
Swedish Match AB (OSTO:SWMA, Financial) (4.8%) (SWMA – $51.55/SEK 482.80 – Stockholm Stock Exchange) produces tobacco products that include snus and snuff, chewing tobacco, cigars, and lights. The company has been benefiting from the growth of the smokeless tobacco market in both Scandinavia and the U.S., as public smoking bans and health concerns are driving consumers to seek alternative tobacco products to cigarettes. In October 2010, Swedish Match combined its European and premium cigar portfolios with Scandinavian cigar and pipe tobacco company STG, creating a new company that should benefit from enhanced scale and synergies. In February 2016, STG went public via an IPO on the Copenhagen Stock Exchange, with Swedish Match fully exiting its stake by 2017. The company has a tobacco-free nicotine pouch product called ZYN that is growing rapidly in the U.S. and Scandinavia, and is driving growth in its mass market cigar business through its new natural leaf products. In October 2019, the company’s General Snus brand was deemed a modified risk tobacco product (MRTP) by the FDA. We expect Swedish Match to continue to grow its cigar and smokeless business globally, and the company could be an attractive takeover candidate for a global tobacco company that wants to increase its presence in the smokeless segment.
The Walt Disney Company (DIS, Financial) (1.6%) (DIS – $144.63 – NYSE) Disney’s direct-to-consumer platform, Disney+, had a successful launch in November 2019. Given the service’s breadth of high-quality content and low $6.99/month and $69.99/year price, we expect Disney’s 60-90 million 2024 global-subscriber target to be achievable and perhaps conservative. Once established, Disney+ should benefit from pricing power given its peers are priced at $10+ per month. Moreover, we expect the subscription streaming business to benefit from attractive marginal economics and rapid margin expansion at scale. Parks & consumer products remain in secular growth. New projects such as Shanghai Disney, the Disney Cruise Line ship expansions, and attendance and pricing growth associated with new lands will drive continued profit growth. Declining capital intensity will translate EBITDA growth into free-cash-flow.
ViacomCBS (VIACA, Financial) (11.2%) (VIACA – $44.87 – NASDAQ) is the product of the December 2019 recombination of Viacom and CBS, two Sumner Redstone controlled companies. ViacomCBS is a globally-scaled content company with networks including CBS, Showtime, Nickelodeon, MTV, Comedy Central, VH1, BET, thirty television stations, the Simon & Schuster publishing house and the Paramount movie studio. The companies separated in 2005, but changes in the media landscape have put a premium on global scale. Together ViacomCBS should be able to better navigate shifts in consumer behavior and monetization while generating significant cost savings and enhancing revenue growth.
Conclusion
A new decade doesn’t guarantee a new investing paradigm, but the alternating dominance of Growth and Value has historically run in cycles. The current cycle is long in the tooth. We continue to search for and find value in the growth dynamics of certain companies, but we have not changed our core approach and are ready for any relative market tailwind. We construct portfolios from the bottom up in a way that makes us look different from any index. Over a long period, we believe being idiosyncratic, relying on ideas that can generate positive returns irrespective of economic conditions, is the best way for us to add value to (y)our Fund.
1. Technically, the next decade does not begin until January 1, 2021 as the Gregorian calendar starts with Year 1, but we'll abide by the popular notion of welcoming new decades on years ending in zero.
Note: The views expressed in this Shareholder Commentary reflect those of the Portfolio Managers only through the end of the period stated in this Shareholder Commentary. The Portfolio Managers’ views are subject to change at any time based on market and other conditions. The information in this Portfolio Managers’ Shareholder Commentary represents the opinions of the individual Portfolio Managers and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. Views expressed are those of the Portfolio Managers and may differ from those of other portfolio managers or of the Firm as a whole. This Shareholder Commentary does not constitute an offer of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this Shareholder Commentary has been obtained from sources we believe to be reliable, but cannot be guaranteed.
