Trailing Twelve Months (TTM) Contributors
Fabrinet (FN, Financial) is a contract manufacturer of optical communications sensors and equipment. The companyhas dominant scale in hard-to-replicate precision-manufacturing technologies and an enviable track record of execution. The majority of sales are to optical communications equipment manufacturers, but Fabrinet has been successfully diversifying into the data center, industrial, auto, and medical end-markets. The stock jumped after reporting June 2023 earnings – datacenter sales increased 50% sequentially and more than 100% over the previous year, driven by their 800-gigabyte transceivers for Artificial Intelligence applications. The company also announced that Nvidia is a 10%+ customer.9 Fabrinet was a top-five holding in the Fund before their latest earnings announcement and, although we have trimmed our position, is currently the largest holding. While we continue to evaluate what we believe is a positive step change in the company's earnings power, we are seeking to take some profits in keeping with our risk management policies.
InterDigital (IDCC, Financial) is a research and development organization that develops and acquires wireless and videopatents across key technologies. The company has a history of strong financial performance, opportunistically buys back shares, and pays a modest dividend. Shares jumped earlier this year when InterDigital announced licensing renewals with Samsung, LG, and Panasonic and then reported strong fourth quarter 2022 results.10
Deckers (DECK, Financial) is a footwear and apparel company that owns the UGG, Hoka, Teva, Sanuk, and Koolaburra Management has done a masterful job growing and extending the UGG franchise. Now they are repeating their success with Hoka running shoes which surpassed $1 billion in sales last year.11 At over 20 times earnings (as of Sep 30, 2023), we have weighed Deckers' full valuation against the quality of the management team, strong brands, and net cash balance sheet and are comfortable with the Fund's current position.
AEL (AEL, Financial) is a leading writer of fixed-index annuities. The company is undergoing an ambitioustransformation plan, led by CEO Anant Bhalla, to diversify into alternatives and move assets off balance sheet, creating a fee income stream and freeing up-capital for buybacks (a program they refer to as AEL 2.0). As of 23Q2, AEL had 25% of its balance sheet in private assets.12 The company has had several takeover offers over the years and on June 27, 2023 Brookfield bid $55 per share for the business.13
MasTec (MTZ, Financial) is a contractor that builds and repairs infrastructure for telecoms, electric utilities, oil and gaspipelines, and the clean energy industry. The Mas brothers have an impressive history of rolling up smaller players and growing earnings, most recently in the electrical and clean energy sectors.14 The company is benefiting from strong spending for 5G in telecom and government support (including the Infrastructure Investment and Jobs Act) for clean energy and the electrical grid.15 We took profits and reduced our position as MasTec's story outran the company fundamentals earlier this year. In its second quarter earnings release, the company reduced 2023 guidance citing project delays, and the stock retraced some of its earlier gains.16
Trailing Twelve Months (TTM) Detractors
United Natural Foods (UNFI, Financial)
distributes natural and organic food. Whole Foods is a 20% customer,but UNFI has done a reasonable job diversifying its product and customer base, with a big boost from its acquisition of SuperValu in 2018.17 The company's share price has declined with three successive earnings misses and guidance revisions this year.18 UNFI is suffering from a combination of volatile food prices, consumers trading down from high-priced organic food items, and pricing and execution mistakes by the company. Distribution is usually a resilient business model and, on a normalized basis, UNFI looks cheap. But the company is now in full-bore turnaround mode, and we have been judicious about adding to our position.
ServisFirst Bank (SFBS, Financial)
is a conservatively-run lending franchise led by founder Tom Broughton. ServisFirsthires local bankers but doesn't build branches, which promotes best-in-class efficiency metrics while maintaining a strong and conservative lending culture. Return on equity (ROE) and average earnings-per-share growth have been near 20% for the last 10 years through year end 202219 – very attractive results for a conservative, vanilla commercial lender. ServisFirst shares declined significantly following the failure of Silicon Valley Bank but have outperformed the regional bank ETFs on a year-to-date basis.20 We think investors are concerned about ServisFirst's uninsured commercial deposits and the stock's premium price-to-book valuation. But we are comfortable that although the bank will raise deposit rates, its commercial relationships are sticky, and ServisFirst's high net interest margin and return on equity (ROE) will allow it to weather the storm better than its competitors. SFBS' 23Q2 earnings report validated our confidence in the company.21Concentrix (CNXC, Financial) is one of the top two customer experience (CX) vendors globally. The company started offmanaging call centers but has since evolved into a high-tech business process outsourcer (BPO) that also designs and runs customer-facing websites and apps, integrates the data, and optimizes a client's customer interactions. CX is a relatively new business, and Concentrix has been acquiring smaller competitors. In March, 2023 they bought WebHelp, a leading European CX player, for $4.8B in cash and stock.22 We believe the WebHelp acquisition will help consolidate an industry where Concentrix and Teleperformance are the largest players. The company was spun out from TD Synnex, another of the Fund's core holdings, and we have always been impressed with the company's innovation and growth. The market is currently worried about the potential of artificial intelligence to disrupt Concentrix' core call center business and shares of all CX companies have underperformed.23
UGI Corp (UGI, Financial) owns gas utilities and pipelines in Pennsylvania and West Virginia and the largest propanedistribution businesses in the United States and Europe. This is our kind of company – despite its disparate parts, UGI has increased earnings at a relatively steady high single digit rate historically while distributing excess cash through dividends.24 We believe shares are down primarily because of poor execution at AmeriGas, UGI's U.S. propane business, but also because of losses at the company's European energy marketing business and the negative effects of warm weather on earnings. We believe UGI is attractive at less than 10x earnings, and we have been incrementally adding to the Fund's position.
Livent (LTHM, Financial) is an integrated, low-cost lithium producer that was spun out from FMC in 2018. This is anunusual investment for us - we normally avoid the commodity and materials sectors and have kept our position in Livent small. But we believe Livent has a unique position in an industry with a strong long-term outlook. The company generates cash, is virtually debt-free (as of Sep 30, 2023), and has considerable capacity additions planned near-term. In May, Livent announced an all-stock combination with Australia's Allkem that should add scale, allow for cost reductions, and help consolidate the market. 25 The company's share price has declined along with lithium prices despite Livent's relatively long-term contracts and reiteration of 2023 guidance.26
Portfolio Positioning
The Fund's cash position is generally a residual of the investment process. When we cannot find companies that meet our stringent criteria, we will allow cash to build. Over the long term, we would prefer to own a diversified portfolio of quality companies (acquired at reasonable prices) instead of cash. But we weigh this objective against our reluctance to sacrifice a margin of safety and risk of permanent impairment of-capital. At quarter end, our cash position was 9.7%.
During the quarter, we added one new position, added to fifteen current holdings, and reduced one current holding.
Despite the recent market volatility and an uncertain macro environment, we feel better about the Fund's long-term prospects than we have in quite some time. We do not make short term predictions on market direction. But the current portfolio valuations, competitive positions, and track records of execution of the Fund's holdings give us confidence that they will be worth more in three-to-five years than they are today.
As always, and as significant co-investors in the Fund, we appreciate your trust in us to be good stewards of your-capital. If you would like to discuss performance or the Fund's portfolio holdings in greater detail, please let us know.
Respectfully,
Steve Scruggs, CFA, Portfolio Manager
Ben Mellman, Senior Analyst
October 13, 2023
9 Source: Fabrinet fiscal Q4 2023 earnings release and call; https://investor.fabrinet.com/events/event-details/fabrinets-fourth-quarter-2023-financial-results-conference-call
10 Source: Foss Patents; InterDigital announces arbitration agreement with Samsung, renewal with Panasonic, video codec license deal with LG; January 2023; http://www.fosspatents.com/2023/01/interdigital-announces-arbitration.html; Source: InterDigital; InterDigital Press Release; January 2023; https://ir.interdigital.com/news-events/press-releases/news-details/2023/InterDigital-Issues-Preliminary-Financial-Results-for-Fourth-Quarter-2022/default.aspx
11Source: Deckers Dec-22 earnings release and presentation; https://ir.deckers.com/news-events/press-releases/press-release/2023/DECKERS-BRANDS-REPORTS-THIRD-QUARTER-FISCAL-2023-FINANCIAL-RESULTS/
12 Source: AEL 23Q2 earnings release; https://ir.american-equity.com/financial-reporting/quarterly-results
13Source: https://www.wsj.com/articles/brookfield-seeks-hard-to-get-prize-in-american-equity-deal-d8e02445
14Source: MasTec; July 2022; https://www.mastec.com/press-release/2286/mastec-to-acquire-infrastructure-and-energy-alternatives-inc-iea-a-premier; December 2021; https://www.mastec.com/press-release/2259/mastec-to-acquire-henkels-mccoy-a-premier-utility-services-provider; May 2021; https://www.mastec.com/press-release/2245/mastec-expands-electrical-distribution-operations-footprint-with-acquisition-of-i
15 Source: Factset; See discussion at the Credit Suisse Industrials Conference; Dec 1, 2022.
16 Source: Mastec 23Q2 earnings release and call; https://investors.mastec.com/news-releases/news-release-details/mastec-announces-second-quarter-2023-financial-results-record
17 Source: UNFI Annual Report; July 30, 2022; page 12, https://s22.q4cdn.com/589001886/files/doc_financials/2022/annual/UNFI-2022-10-K-as-filed.pdf
18 Source: UNFI fiscal 23Q2, 23Q3 and 23Q4 earnings releases and calls; https://ir.unfi.com/financials/quarterly-results/default.aspx
19 Source: Factset. Cumulative average growth rate is based on diluted earnings per share for year ends 2013-2022.
20 Source: Factset. YTD performance for SFBS vs. iShares US Regional Banks ETF (ARCX: IAT) and SPDR S&P Regional Banking ETF (ARCX: KRE) Sep 30, 2023].
21 Source: ServisFirst Bank 23Q2 earnings release and call; https://www.servisfirstbancshares.com/news-events/events-presentations
22Source: https://ir.concentrix.com/news-releases/news-release-details/concentrix-combine-webhelp-creating-diversified-global-cx-leader,
23 Source: Concentrix fiscal 23Q2 earnings transcript; https://ir.concentrix.com/financials/quarterly-results
24Source: Company financials and Factset.
25Source: https://ir.livent.com/news/news-details/2023/Allkem-and-Livent-to-Create-a-Leading-Global-Integrated-Lithium-Chemicals-Producer/default.aspx
26Source: Livent 23Q2 earnings release and transcript; https://ir.livent.com/financials-and-filings/quarterly-results/default.aspx
Important Disclosures
This Commentary is for informational and discussion purposes only and does not constitute, and should not be construed as, an offer or solicitation for the purchase or sale of any securities, products or services discussed, and neither does it provide investment advice. Any such offer or solicitation shall only be made pursuant to the Fund's Prospectus, which supersedes the information contained herein in its entirety. This Commentary does not constitute an investment management agreement or offering circular.
The statements contained herein reflect the opinions and views of the portfolio managers as of the date written, is subject to change without notice, and may be forward-looking and/or based on current expectations, projections, and/or information currently available. Such information may not be accurate over the long-term. These views may differ from other portfolio managers and analysts of the firm as a whole and are not intended to be a forecast of future events, a guarantee of future results or investment advice.
Portfolio composition will change due to ongoing management of the Fund. References to individual securities or sectors are for informational purposes only and should not be construed as recommendations by the Fund, the portfolio manager, the Adviser, the Sub-Adviser or the distributor. It should not be assumed that future investments will be profitable or will equal the performance of the security or sector examples discussed. The portfolio holdings as of the most recent quarter-end may be obtained at www.fpa.com.
Future events or results may vary significantly from those expressed and are subject to change at any time in response to changing circumstances and industry developments. The information and data contained herein has been prepared from sources believed reliable, but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data.
The information contained herein is not complete, may change, and is subject to, and is qualified in its entirety by, the more complete disclosures, risk factors, and other information contained in the Fund's Prospectus and Statement of Additional Information. The information is furnished as of the date shown. No representation is made with respect to its completeness or timeliness. The information is not intended to be, nor shall it be construed as, investment advice or a recommendation of any kind.
Certain statements contained in this presentation may be forward-looking and/or based on current expectations, projections, and information currently available. Actual events or results may differ from materially those we anticipate, or the actual performance of any investments described herein may differ from those reflected or contemplated in such forward-looking statements, due to various risks and uncertainties. We cannot assure future results and disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Such statements may or may not be accurate over the long-term. Statistical data or references thereto were taken from sources which we deem to be reliable, but their accuracy cannot be guaranteed.
The reader is advised that the Fund's investment strategy includes active management with corresponding changes in allocations from one period of time to the next. Therefore, any data with respect to investment allocations as of a given date is of limited use and may not be reflective of the portfolio manager's more general views with respect to proper geographic, instrument and /or sector allocations. The data is presented for indicative purposes only and, as a result, may not be relied upon for any purposes whatsoever.
In making any investment decision, you must rely on your own examination of the Fund, including the risks involved in an investment. Investments mentioned herein may not be suitable for all recipients and in each case, potential investors are advised not to make any investment decision unless they have taken independent advice from an appropriately authorized advisor. An investment in any security mentioned herein does not guarantee a positive return as securities are subject to market risks, including the potential loss of principal. You should not construe the contents of this document as legal, tax, investment or other advice or recommendations.
Fund performance presented is calculated on a total return basis, which includes the reinvestment of all income, plus realized and unrealized gains/losses, if applicable. Unless otherwise indicated, performance results are presented on a net of fees basis and reflect the deduction of, among other things: management fees, brokerage commissions, operating and administrative expenses, and accrued performance fee/allocation, if applicable.
The information provided in this presentation is based upon data existing as of the date(s) of the report and has not been audited or reviewed. While we believe the information to be accurate, it is subject in all respects to adjustments that may be made after proper review and reconciliation.
Investments, including mutual fund investments, carry risks and investors may lose principal value. Capital markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Small and mid-cap stocks involve greater risks and they can fluctuate in price more than larger company stocks. Short-selling involves increased risks and transaction costs. You risk paying more for a security than you received from its sale. Groups of stocks, such as value and growth, go in and out of favor which may cause certain funds to underperform other equity funds. The value of an individual security can be more volatile than the market as a whole and can perform differently than the value of the market as a whole.
The Fund primarily invests in equity securities (common stocks, preferred stocks and convertible securities) of small-capitalization U.S. companies, defined as those with market-capitalization, at the time of purchase, that is no greaterthan the largest market-capitalization of any company included in the Russell 2000 Index. Investing in small companies involves special risks including, but not limited to, the following: smaller companies typically have more risk and their company stock prices are more volatile than that of large companies; their securities may be less liquid and may be thinly traded which makes it more difficult to dispose of them at prevailing market prices; these companies may be more adversely affected by poor economic or market conditions; they may have limited product lines, limited access to financial resources, and may be dependent on a limited management group; and small-cap stocks may fluctuate independently of large-cap stocks. All investment decisions are made at the discretion of the Portfolio Manager, in accordance with the then current Prospectus. Comparison to any index is for illustrative purposes only.
The prices of securities held by the Fund may decline in response to certain events taking place around the world, including those directly involving the companies whose securities are owned by the Fund. Securities in the Fund's portfolio may underperform due to inflation (or expectations for inflation), interest rates, global demand for particular products or resources, natural disasters, pandemics, epidemics, terrorism, regulatory events and governmental or quasi-governmental actions. There is a risk that you may lose money by investing in the Fund.
Value style investing presents the risk that the holdings or securities may never reach their full market value because the market fails to recognize what the portfolio management team considers the true business value or because the portfolio management team has misjudged those values. In addition, value style investing may fall out of favor and underperform growth or other styles of investing during given periods.
Please refer to the Fund's Prospectus for a complete overview of the primary risks associated with the Fund.
The FPA Funds are distributed by UMB Distribution Services, LLC, 235 W. Galena Street, Milwaukee, WI, 53212. UMB and FPA are not affiliated.
