To Our Shareholders,
For the quarter ended September 30, 2017, the net asset value (“NAV”) per Class A Share of The Gabelli Value 25 Fund increased 2.4% compared with increases of 4.5% and 5.6% for the Standard & Poor’s (“S&P”) 500 Index and the Dow Jones Industrial Average, respectively. See page 2 for additional performance information.
Third Quarter Commentary
The U.S. stock market advanced to record highs in September, with the S&P 500 in positive territory for an eighth consecutive quarter. The fundamental narrative remains favorable, thanks in large part to an upswing in global growth and still supportive global monetary policy. Economic indicators continue to point upwards around the world, with low inflation, falling unemployment, and rising consumer spending all contributing to the stock market’s rise. Reported second quarter earnings were, by and large, better than expected, with many companies beating sales and earnings forecasts and reaffirming or raising full year guidance. Furthermore, the weak dollar is helping to increase reported overseas profits for U.S. based multinationals and could potentially boost U.S. exports.
The Trump administration’s policies came back into focus during the quarter with the announcement of a deal to extend the debt ceiling and the release of a highly anticipated tax reform blueprint. More surprising than the across the aisle handshake from President Trump and Democrats on the debt ceiling agreement was the market’s positive reaction to tax cut expectations, the possibility of which had been dwindling after several legislative setbacks on healthcare reform. The discussion around tax reform spurred renewed momentum around reflation trades and hope for fiscal stimulus. If a bill resembling the current plan is passed, it will likely be a boon for the U.S. economy and stock market, with industrial companies and domestic-oriented, full cash tax paying small cap stocks being among the biggest winners. Consumer spending may also get a boost from reductions in rates for individuals. Ultimately, the devil is in the details, and the Trump administration has not yet shown the ability to advance much of its agenda, but we remain cautiously optimistic that taxes for individuals and corporations will be lower in 2018.
Of course, risks always remain, most notably the very public nuclear brinksmanship with North Korea. Any military conflict that could occur has the potential to carry with it an enormous human cost in terms of loss of life. While of lesser importance, it would likely result in a sharp decline in stock prices as well. We are hopeful that a diplomatic solution prevails, and note that in this new era of uncertain geopolitical dynamics, military spending will likely remain robust for years to come.
Deals, Deals & More Deals
Merger and acquisition (M&A) activity, while still robust, has not meaningfully accelerated under the Trump administration, as CEOs and boards wait for more clarity on taxes and potential regulatory scrutiny. Worldwide M&A activity totaled $2.4 trillion during the first nine months of 2017, a 3% increase compared with the first nine months of 2016. Overall, 35,360 worldwide deals were announced during the first nine months of 2017, flat compared with a year ago. As soon as policy uncertainties in Washington regarding corporate tax reform, international trade, and various industry reform and deregulation initiatives begins to lift, a resurgence in deal making may start.
Conclusion
Markets continue to climb, but risks – geopolitical and otherwise – as always remain. We continue to seek high-quality companies trading at a discount to Private Market Value – the price an informed industrialist would pay to own an entire business – and hope to use any opportunity “Mr. Market” provides to us. We also look for catalysts to surface value, such as industry consolidation, financial engineering, new management, regulatory changes, or a change in cash flow allocation. Finally, tax reform has the potential to increase consumer spending, corporate profits, and lead to an acceleration of deal making activity.
Investment Scorecard
Performance in the quarter was led by Aerojet Rocketdyne (2.2% of net assets as of September 30, 2017) and Navistar (1.5%), each up 68%. Aerojet, a provider of liquid, solid and air-breathing propulsion systems, had been strong in the anticipation of growth in defense and space spending; it received a further boost after Northrup Grumman announced the acquisition of competitor Orbital ATK. Truck-maker Navistar is in the early stages of market share recovery and is increasingly collaborating with 17% owner – and potential acquirer – Volkswagen.
Financials contributed positively in the third quarter, led by card networks American Express (3.4%) and MasterCard (1.3%). Finally, Scripps Networks Interactive (0.1%), owner of the HGTV, Food and Travel channels, was a contributor as peer Discovery Communications (0.6%) announced in July it would acquire the company for cash and stock.
Other than Scripps, media network owners including CBS (6.6%), Viacom (5.2%), Discovery (0.6%) and Twenty-First Century Fox (1.7%), detracted from performance on fears of accelerated cord cutting and cyclical advertising pressures. DISH Network (1.9%), whose assets include the second largest satellite TV platform and the largest over-the-top platform (Sling) in the U.S. as well as a significant spectrum portfolio, retraced its gains for the year on those same cord-cutting concerns and uncertainty about how it would monetize its spectrum holdings in light of a potential T-Mobile (0.8%)/Sprint merger. Finally, increased prospects for tax reform and the simplification it might bring weighed on H&R Block (0.7%), the largest assistance tax preparation company in the U.S.
Let’s Talk Stock
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 September 30, 2017.
Aerojet_Rocketdyne_Holdings_Inc._(2.2%_of_net_assets_as_of_September_30,_2017)_(AJRD_–_$35.01_–_NYSE) (AJRD, Financial), 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.
Bank_of_New_York_Mellon_Corp._(3.2%)_(BK_–_$53.02_–_NYSE) (BK, Financial) 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 June 2017, the firm had $31.1 trillion in assets under custody and $1.8 trillion in assets under management. Going forward, we expect BK to benefit from rising global incomes and the cross border movement of financial transactions. We believe BK is also well positioned to grow earnings in a rising interest rate environment, given its large customer cash deposits and significant loan book.
CBS_ Corp._ (6.6%)_ (CBS_ –_ $58.41_ –_ NYSE)(CBS, Financial) operates the CBS television network and the premium cable network Showtime. It also owns 29 local television stations and 130 radio stations. We believe that CBS has a number of opportunities to generate incremental non-advertising revenue from the sale of existing content through its OTT platforms, online video distributors and retransmission agreements with traditional distributors. In addition, we expect a continued recovery in advertising to contribute to earnings growth. Finally, we believe that financial engineering, including the split-off of its radio business, could act as a catalyst for shares.
Diageo_plc_(3.3%)_(DEO_–_$132.13_–_NYSE)(DEO, Financial) 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.
Honeywell_International_Inc._(3.1%)_(HON_–_$141.74_–_NYSE) (HON, Financial) operates as a diversified technology company with highly engineered products, including turbine propulsion engines, auxiliary power units, turbochargers, brake pads, environmental and combustion controls, sensors, security and life safety products, resins and chemicals, nuclear services, and process technology for the petrochemical and refining industries. One of the key drivers of HON’s growth is acquisitions that increase the company’s growth profile globally, creating both organic and inorganic opportunities. The company recently acquired Intelligrated, a leader in supply chain and warehouse automation technologies. Intelligrated’s mission critical warehouse execution systems and software complement Honeywell’s scanning, mobile computer, and voice automation technologies. Intelligrated’s U.S. leadership position with opportunity to expand into a global addressable market of approximately $20 billion through Honeywell’s footprint. We believe acquisitions such as Intelligrated should drive meaningful and sustained growth for HON spurred by an industry growing at a double digit rate with Intelligrated as a market leader.
Madison_ Square_ Garden_ Co._ (3.8%)_ (MSG_ –_ $214.10_ –_ NYSE) (MSG, Financial) 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.
Newmont_Mining_Corp._(3.4%)_(NEM_–_$37.51_–_NYSE) (NEM, Financial) based in Denver, Colorado, is one of the largest gold mining companies 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. We expect the company to produce approximately 5.3 million ounces of gold and 120 million pounds of copper in 2017, with approximately 70% of this production coming from the United States and Australia. Newmont undertook company wide cost cutting measures during the period 2013 – 2016, lowering its average unit costs base by over 20% during this period. The company has sold non-core assets and has deployed the proceeds from these sales into repaying debt and building new projects which it expects will generate superior rates of return for shareholders. Given Newmont’s largely fixed cost base, every increase (or decrease) in the gold price will flow directly to the company’s bottom line.
Republic_Services_Inc._(4.4%)_(RSG_–_$66.06_–_NYSE) (RSG, Financial), 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 thirty-nine states and Puerto Rico. Republic serves more than 2,800 municipalities and operates 192 landfills, 204 transfer stations, 333 collection operations, and 64 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._(4.2%)_(SNE_–_$37.34_–_NYSE) (SNE, Financial) is a diversified electronics and entertainment company based in Tokyo, Japan. The company manufactures televisions, PlayStation game consoles, mobile phone handsets, and cameras. It also operates the Columbia film studio and Sony Music entertainment group. We expect the new PlayStation launch and operational improvements in consumer electronics and entertainment to generate EBITDA growth through 2018. We also think the spinoff of the entertainment assets could be a catalyst.
October 27, 2017
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.
