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Sydnee Gatewood
Sydnee Gatewood
Articles (3098) 

Mario Gabelli's Gabelli Value 25 Fund 2nd-Quarter Shareholder Commentary

Discussion of markets and holdings

To Our Shareholders,

For the quarter ended June 30, 2020, the net asset value (NAV) per Class A Share of The Gabelli Value 25 Fund increased 18.7% compared with an increase of 20.5% for the Standard & Poor's (S&P) 500 Index. Other classes of shares are available. See page 2 for additional performance information for all classes.

Introduction: 2020 Visibility Limited?

Extraordinary times require renewed focus on what we and all fundamental investors practice in some form or another: the estimation of the value of a security based upon a forecast of its future cash flows. Such an exercise requires views on the size and growth of a company's addressable market, its strategic position within that market and the level and direction of interest rates, inflation and taxation, among other things. The explosion of COVID-19 in early 2020 clouded and had the potential to drastically reshuffle those variables, resulting in a 34% peak-to-trough market retrenchment in February and March 2020.

COVID-19 has triggered a peculiar recession, one largely caused or worsened by – and that may ultimately be resolved by – government intervention. Officially dated to February 2020, the current recession has been swift, with April unemployment of 14.7% quickly exceeding the Great Recession peak of 10.6% in January 2010. After declining 5% in Q1, second quarter GDP declined 33%, the sharpest falloff on record. This recession may turn out, however, to be shorter than the 18-month average duration, with the shape of the recovery – V, U, L, W, and even just a Swoosh are some of the often-cited images – influenced by the trajectory of the virus. Economic indicators have already evidenced a rebound, but that could stall with local breakouts of COVID-19. Corporate earnings in 2020 will be poor but largely behind us as we look forward to easier comparisons in 2021.

We'll forego the armchair epidemiology and distill the many outstanding questions about COVID-19 into one: when do we reach the point of indifference? That is, when will the average consumer feel comfortable eating inside a restaurant, getting on an airplane, or going to a sporting event, whether because of a vaccine, herd immunity, an effective treatment or simply quarantine fatigue. We don't know when that point will be, and it almost certainly won't be a discrete date. Rather, it will be a process, already playing out, of living with some uncertainty while resuming economic activity. Sometime in early 2021 seems a reasonable estimate of that point of indifference; it may be sooner or later, but the short-term impact of COVID-19 on our society and economy will wane and unprecedented global fiscal and monetary stimulus should adequately cushion the downside. With the S&P 500 Index posting its best second quarter since 1938 with a 21% rise, that is the judgement the market as a whole appears to be making.

The Political Economy of COVID-19

A more interesting question is whether and how COVID-19 and its attendant responses impact the long term outlook for equities. At a minimum, COVID-19 appears to have accelerated three trends that have been building for a decade or more:

Digitization – As lockdown has forced sometimes reluctant consumers, businesses and governments to change their habits, the way we shop, work, learn and recreate have been changed forever. The adoption curve for many technologies has been pulled forward and new markets have been expanded and created (e.g., connectivity, e-commerce, payment systems) to support "distanced" activities. Winning and losing companies and sectors are already being sorted.

De-globalization – Travel bans have joined trade barriers as the newest incarnation of beggar-thy-neighbor policies. A drive toward self-sufficiency, in at least critical supplies, and tighter control of population movements, will likely be lasting effects of COVID-19. Condemnation of China's initial handling of the virus appears to be one of the few bipartisan issues remaining and will further accentuate the new Cold War.

Disunity – A popular view holds that the fraying of America's social fabric, abetted by globalization, rising income inequality and growing cultural divisions, led to the election of Donald Trump. Many of those same issues, on display in protests not seen since the 1960s, may carry him out of office in November. This year's election (spoiler alert: the focus of our Q3 missive) will surely be contentious, and a flip of the White House and Senate could have important policy ramifications. But those may be details when compared with the existential threat capitalism faces today. A large population not "bought in" to the present system is difficult to discount into current stocks prices but an eventuality that needs to be considered.

Notwithstanding these overarching issues, life after COVID-19 is likely to be more the same than different than life before COVID-19 (BC). Incremental fiscal stimulus under the $2 trillion CARES Act and an accommodative Federal Reserve pave the way for higher taxes and the best chance at a return to inflation in many years no matter who holds the White House. Normally these dynamics would result in lower future real economic growth and thus lower market multiples. That is decidedly not the case with the S&P 500 trading at 19x 2021E earnings even before a potential corporate tax increase. Among the solutions to this puzzle are an expectation that consumer spending will outweigh any drag from the crowding out of more debt and taxes or that, in a zero rate environment, there are no good alternatives to stocks. "Don't fight the Fed" has been a maxim well heeded over the last market cycle.

Mr. Market

A Rip Van Winkle who only checks the market semi-annually might be excused for thinking nothing was amiss this year. Through June 30, the S&P 500 was off a mere 3%, having rallied almost 40% from its March low. Growth stocks continued their winning streak, powered by Facebook, Amazon, Netflix, Google/Alphabet, Microsoft and Apple (the "FANGMA"). At mid-year, these six stocks had an aggregate market capitalization of $6.3 trillion, comprising 23% of the S&P 500 Index and contributing 5.4 points of positive year-to-date return. In some ways, the leadership of these stocks is not surprising as most possess exceptional balance sheets and offer services even more in demand under lockdown. Unlike the bellwethers of the 1990s technology bubble and certain technology "story" stocks today, the FANGMA offer real cash flow that underpins their nation-state status. In an uncertain low growth/low interest rate environment, this growth profile commands a premium. How these stocks perform in a full blown economic recovery and how large they can get, especially when under increasing government scrutiny, remains a question.

A preview of what recovery may ultimately bring for stocks occurred briefly in late May/early June when smaller capitalization and value stocks snatched market leadership before reversing (the Russell 2000 and Russell 3000 Value, which track smaller cap and value stocks, respectively, remained down 14% and 17% at June 30). Historically value, which includes a disproportionate number of cyclically sensitive firms, and small cap have led performance early in the economic cycle. These stocks may have jumped the gun in early June, but in many cases remain at bargain valuations that could provide significant upside as clarity on the shape of recovery increases.

Investment Scorecard

The largest contributor to returns in the second quarter was ViacomCBS (7.9% of net assets as of June 30, 2020, +45%). Like many media companies, ViacomCBS was hit hard in the first quarter by lower advertising revenue, a lack of sports programming, theater closures and the suspension of film and TV production. The Q2 rebound was driven by sequentially improving advertising, the support of less cyclical subscription revenue streams and cost savings derived in part from the integration of Viacom and CBS. Swedish Match (7.8%, +30%) continued to deliver strong and reliable results as it expands distribution of Zyn nicotine patches globally. After lagging in Q1, DISH Network (2.0%, +85%) rose in anticipation of additional communication of a wireless strategy that should be abetted by the recent acquisition of assets from the T-Mobile/Sprint merger. Finally, Newmont Mining (8.4%, +34%) continued higher on the back of gold prices that are rising with expectations for inflation fed by fiscal and monetary stimulus.

DISH Network spin-off Echostar Corp. (0.9%, -8%) was the largest detractor from returns owing to concerns that it would lose share to emerging satellite broadband companies, including SpaceX and Amazon. Despite steady results from its cable operations, Grupo Televisa (0.6%, -3%) remains subject to a cyclical downturn, exacerbated by COVID-19, in Mexico. Finally, Wells Fargo (0.9%, -3%) will have to contend not only with lower interest rates but limits on growth imposed by its regulator in response to past fraudulent sales practices.

Conclusion

As individuals we prefer to walk the sunny side of the street; as securities analysts we look down before we look up on those strolls. With the consequences of COVID-19 still unfolding, there is likely to be more pain in an uneven recovery, but we leave open the possibility that recovery will be faster than even the market appears to be discounting. While it is difficult to discern any silver linings in the present crisis, it has at times underscored the centrality of caring for one another and highlighted the adaptability of many enterprises large and small. Ultimately, there has been a widespread display of organic entrepreneurship that built this country and leaves us optimistic for America's future and its ability to grow wealth for all, including through patient, disciplined investment.

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 June 30, 2020.

Aerojet Rocket Holdings (NYSE:AJRD) (3.3% of net assets as of June 30, 2020) (AJRD – $39.64 – NYSE), based in El Segundo, California, is a manufacturer of aerospace and defense products and systems for defense and space applications. The manufacturing operation is a leading technology based designer, developer, and manufacturer of aerospace and defense products for the U.S. government, including the Department of Defense and NASA. AJRD also manufacturers products for other governmental contractors and the commercial sector. The company also has significant real estate holdings, including significant land holdings east of Sacramento, California. AJRD is in the process of gaining governmental approvals to optimize the value of the land. These convertible bonds provide a lower volatility way to invest in AJRD. The bonds provide a reasonable yield, where the stock does not pay a dividend.

American Express Co. (NYSE:AXP) (4.0%) (AXP – $95.20 – 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 March 2020, American Express has 114 million cards in force and nearly $92 billion in loans, while its customers charged $1.2 trillion of spending on their cards in 2019. 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.

Diageo plc (NYSE:DEO) (3.0%) (DEO – $134.39 – NYSE) is the leading global producer of alcoholic beverages, with brands including Smirnoff, Johnny Walker, Ketel One, Captain Morgan, Crown Royal, J&B, Baileys, Tanqueray, and Guinness. The company has a balanced geographic presence in both mature and emerging markets, and it benefits from the trend of consumers around the world trading up to premium products. Over the past several years, Diageo made acquisitions that enhanced its presence in emerging markets: a majority stake in United Spirits, the leading spirits producer in India; Mey Icki, the leading spirits company in Turkey; Shui Jing Fang, a leading Chinese baiju producer; Ypioca, the leading cachaca producer in Brazil; and an increased stake in Halico, the leading domestic spirits producer in Vietnam. While economic conditions in emerging markets have created headwinds for some of these investments recently, the long term fundamentals of the spirits industry remain very favorable, and Diageo will be one of the largest beneficiaries of industry growth.

DISH Network Corp. (NASDAQ:DISH) (2.0%) (DISH – $34.51 – NASDAQ) is the fourth largest pay television provider in the U.S., serving approximately 11 million subscribers through its original satellite business and newer Sling internet delivered over-the-top offering. Founder Charlie Ergen owns approximately half of DISH's shares. DISH has accumulated a significant spectrum position at attractive prices. DISH could monetize its spectrum through a sale of the spectrum or the whole company, or, more likely, a partnership with an existing wireless operator or new entrant to the industry such as Amazon. DISH consummated its acquisition of Boost Mobile from Sprint/T-Mobile in July 2020 which should accelerate its entry into the wireless industry.

Liberty Global plc (NASDAQ:LBTYK)(NASDAQ:LBTYA) (0.7%) (LBTYK/LBTYA – $21.51/$21.86 – NASDAQ) is the leading international cable operator, offering advanced video, telephone, and broadband Internet services. The company operates broadband communications networks in six European countries, under brands that include UPC, Virgin (U.K.), and Telenet (Belgium). In December 2017 Liberty spun-off its Latin American and Caribbean cable and wireless assets in an entity known as "LiLAC." Liberty continues to refine its portfolio, having sold its German operations to Vodafone and agreeing in May 2020 to contribute its U.K. business to a JV with Telefonica's O2 Wireless. These deals leave Liberty with ample liquidity to pursue share repurchases or strategic investments.

Madison Square Garden Sports Corp. (NYSE:MSGS) (2.9%) (MSGS – $146.89 – NYSE) Madison Square Garden Co. owned assets including the New York Knicks, the New York Rangers, the Radio City Christmas Spectacular, the Tao restaurant group and the eponymous Madison Square Garden. Madison Square Garden Company completed the separation of its associated regional sports networks in 2015, and further separated into a Sports company (Madison Square Garden Sports Corp., which owns the teams) and an Entertainment company (Madison Square Garden Entertainment Corp. (1.6%) consisting of MSG's concert business, Christmas Spectacular, arenas and development assets including the Spheres in Las Vegas and London) in April 2020. As of result of Covid-19 related restrictions, MSGE suspended development of the Las Vegas Sphere and MSGS has had to navigate an uncertain sports and events calendar. Both companies possess liquid balance sheets and durable asset value however.

Newmont Corporation (NYSE:NEM) (8.4%) (NEM – $61.74 – NYSE) based in Denver, Colorado, is the largest gold mining company in the world. Founded in 1921 and publicly traded since 1925, NEM is the only gold company included in the S&P 500 Index and Fortune 500. Newmont consummated a $10 billion stock for stock merger with Goldcorp in April of 2019 in which it acquired eight high quality gold mines in the Americas. We expect Newmont to produce approximately 6.5 million ounces of gold in 2020 at all-in sustaining costs of $950 per ounce. Post its acquisition of Goldcorp, Newmont is working towards turning around Goldcorp's former underperforming assets and establishing a large, low-cost, well capitalized gold mining business which generates free cash flow at almost any gold price and has the capacity to grow production organically. As such, the company is in the process of cementing its position as the premier gold investment vehicle in the world.

Sony Corp. (NYSE:SNE) (8.3%) (SNE – $69.13 – 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 nearly half of EBITDA (ex-financial) in 2020 following the much anticipated launch of the PlayStation 5, in the 2020 holiday season. Sony Music Recording commands #2 and Music Publishing #1 global share and is a hidden asset as music values have increased with the success of streaming .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. 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 acquired the public minority that it do not own to take 100% control of Sony Financial Services. Sony has net cash on its balance sheet enables the company to manage through COVID-19 and increase its dividend return and introduce a third stock buy back. Online game usage has increased dramatically with stay-at-home restrictions but business such as movies are impacted by production stopping and releases delayed.

Swedish Match AB (SWMA) (7.8%) (SWMA – $70.29/SEK655.00 – 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. The company has a rapidly growing tobacco-free nicotine pouch product called ZYN that is growing rapidly in the US and Scandinavia, and is driving growth in its mass market cigar business through its new natural leaf products. Driven by ZYN, we expect Swedish Match to continue to grow its 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.

ViacomCBS (VIAC) (7.9%) (VIA – $25.60 – 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, 30 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.

August 21, 2020

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.

About the author:

Sydnee Gatewood
I am the editorial director at GuruFocus. I have a BA in journalism and a MA in mass communications from Texas Tech University. I have lived in Texas most of my life, but also have roots in New Mexico and Colorado. Follow me on Twitter! @gurusydneerg

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