All major indices entered a bear market during the second quarter, leading to the worst first half on record for U.S. equities in over 50 years. Decades-high inflation, central-bank tightening, geopolitical conflict, a plunge in tech stocks, steep bond selloff and the implosion of crypto have plagued markets. We believe prices have moved beyond fundamentals with the market pricing in risks of a recession as investors fear a Fed-induced hard landing. Although uncertainty is high and volatility will likely remain elevated, we remain focused on mining value from the carnage of indiscriminate selling by looking past the near-term noise, and instead, taking a long-term view. Against this backdrop Ariel Fund traded -17.57% lower in the quarter, trailing the Russell 2500 Value Index’s loss of -15.39% and the -16.98% return of the Russell 2500 Index.
Several stocks in the portfolio had strong returns in the quarter. Global leader in for-profit education, Adtalem Global Education (ATGE, Financial) traded higher after reportingfinancial results that topped expectations. Management reiterated the full year outlook and raised earnings-per-share guidance to reflect a paydown of debt and the execution of an accelerated share repurchase program. With the recent completion of the Walden acquisition and the divestiture of the financial services segment, ATGE has become a pure-play healthcare education provider with the scale and capabilities to capitalize on robust demand for skilled nurses, MDs and PhDs across the country.
Additionally, toy manufacturer, Mattel, Inc. (MAT, Financial) delivered its highest first quarter results on record for net sales and operating income. This strong performance benefitted from solid brand management, increased points of distribution and retailers stocking inventories to support product launches tied to upcoming theatrical releases. Management reiterated 2022 guidance and noted the company’s growth prospects for 2023 are attractive, particularly with the reintroduction of the Disney Princess and Frozen toy lines, as well as product support around the upcoming Barbie movie. Recent buyout speculation further complemented share price appreciation. We remain encouraged by management’s execution on its strategy to grow market share, improve profitability and generate higher levels of cash flow. We have strong conviction in the leadership team’s ability to transform MAT into an IP driven, high performing toy company.
Leading manufacturer and distributor of floorcovering products, Mohawk Industries Inc. (MHK, Financial) was another top contributor torelative returns in the quarter. Amidst a background of geopolitical tensions and rising inflation, MHK has been able to deliver sales growth, generate strong cash flow, maintain historically low leverage and return capital to shareholders via buybacks. Notably, successful pricing actions continue to offset rapid cost increases and demand remains firm. We are encouraged by strong residential new construction and remodeling spend as well as the recovery in commercial markets. We believe the company will continue to benefit from global and capacity expansion, as well as end-market growth. At current levels, MHK is trading at a 57% discount to our estimate of private market value.
Alternatively, entertainment holding company, Madison Square Garden Entertainment Corp. (MSGE, Financial) weighed on relative resultsin the period. We believe this price action runs counter to the company’s improving long-term fundamental outlook. Management is projecting a record year in the booking business and sees momentum at TAO. We also expect shares to benefit from normalized 2022-23 NBA and NHL seasons, as well as a full-year of online sports betting now live in New York. Looking ahead, we remain bullish on digital access to sports, as well as the opportunity at the Sphere, its coming Las Vegas property. In our view, the underlying value of MSGE’s physical assets coupled with our conviction around management’s expertise make this an attractive opportunity.
Global cruise vacation company Royal Caribbean Cruises Ltd. (RCL, Financial) also traded lower alongside travel and leisure peers as macro fears of a recession created an overhang across the industry. Although near-term booking patterns in certain parts of Northern Europe and the Baltic have slowed considerably due to the Russia/Ukraine conflict, demand for North American and Caribbean-based itineraries has been encouraging. Both onboard spending and forward booking pricing are ahead of pre-pandemic levels. With RCL’s entire fleet returning to service in June, management is projecting positive EBITDA and operating cash flow by 3Q22. Though questions persist around the macro backdrop, RCL has an experienced executive management team with superior operational expertise at its helm, as well as a healthy liquidity position. Over the long-term, we believe the headwinds travel and leisure are experiencing will soften and expect RCL’s fundamentals will prove resilient in the face of adversity. At today’s valuation, RCL is currently trading at a 66% discount to our estimate of private market value.
Lastly, shares of rebranded leading entertainment company, Paramount Global (PARA, Financial), (formerly ViacomCBS Inc.) fell on mixed earnings results. Declining advertising spending in broadcast and filmed entertainment weighed on revenue, while bottom-line results came out ahead. Management also noted their decision to suspend services in Russia which will negatively impact full year earnings growth. Nonetheless, the company continues to display strong business fundamentals. PARA’s fresh array of global content is driving subscriber momentum worldwide across its direct-to-consumer platform with global subscriptions exceeding 62 million active users. Additionally, CBS was ranked the #1 network for the 14th consecutive season and Paramount Pictures opened five #1 films in a row, with Top Gun Maverick grossing over $1 billion to date. At today’s valuation, we believe VIAC’s risk/reward is skewed sharply to the upside.
We did not add any new positions in the quarter. By comparison, we successfully exited leading global provider of data measurement and analytics to the media industry, Nielsen Holdings PLC (NLSN, Financial) following the announcement of itsacquisition by a private equity consortium.
Geopolitical tensions, rising inflation, surging energy prices, supply chain disruptions, slowing growth and concerns around excessive Fed tightening have ignited recessionary fears. In our view, balance sheets of U.S. financial institutions and households are generally in good shape and we continue to be cautiously optimistic this will protect against a severe downturn. With these market dynamics at our back, we are reminded of Warren Buffett (Trades, Portfolio) who said, “Widespread fear is your friend as an investor because it serves up bargain purchases.”1 We remain laser-focused on identifying undervalued, quality companies with unique products or services, durable cost advantages, capable management teams and robust balance sheets. Meanwhile, we are confident in our portfolio positioning, especially since our portfolios are trading at significant discounts to our own internal estimates of private market value. As we have learned from previous market corrections, our long-term, patient approach has proven dark clouds do not last forever.
Performance data quoted represents past performance. Past performance does not guarantee future results. All performance assumes the reinvestment of dividends and capital gains, and represents returns of the Investor Class shares. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. Performance data current to the most recent month-end for Ariel Fund may be obtained by visiting our website, arielinvestments.com. For the period ended June 30, 2022 the average annual returns of Ariel Fund (investor class) for the 1-, 5-, and 10-year periods were -19.14%, +5.58%, and +10.70%, respectively.
This commentary candidly discusses a number of individual companies. These opinions are current as of the date of this commentary but are subject to change. The information provided in this commentary does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security.
