To Our Shareholders,
For the quarter ended March 31, 2019, the net asset value (NAV) per Class A Share of The Gabelli Value 25 Fund increased 10.7% compared with increases of 13.7% and 11.8% 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.
First Quarter Commentary
What a difference a quarter makes.
Just three months ago, the stock market finished 2018 with one of the worst Decembers on record. Mr. Market had a lot to worry about: slowing global growth, an escalating trade war between the U.S. and China, and rising interest rates, which have the effect of lowering the multiple investors are willing to pay for the earnings or cash flows generated by public companies.
Fast forward to now, and we have slowing but still-robust economic conditions, especially in the U.S., where unemployment sits near historic lows. Conventional wisdom is that the U.S. will eventually come to some form of a trade agreement with China. Perhaps most important, the Federal Reserve made an about-face on its tightening stance. Chairman Powell recently said the next move in rates could be either down or up depending on the data. As a consequence, the U.S. 10 Year Treasury, which yielded over 3.2% at one point in the fourth quarter of 2018, yielded less than 2.4% at one point in the first quarter of 2019.
This combination of the sky not actually falling and the Federal Reserve changing course so quickly led to an extraordinary quarter for the stock market. U.S. stocks posted the best quarterly return since 2009 and the best first quarter since 1998. The gains were broad based, as all S&P 500 sectors exceeded five percent for the quarter. Small capitalization stocks and economically-sensitive industrials – which were the hardest hit in the fourth quarter – were among the best performers.
The first quarter also saw the tenth anniversary of the S&P 500’s intraday bear market low of 666 in 2009 that marked the end of the Global Financial Crisis. This serves as a reminder that, while Mr. Market is in a far better mood now than around the 2018 holidays, risks always remain. Our time-tested methodology of seeking businesses trading at discounts to Private Market Value with catalysts to surface value has served us well through both up and down markets in the past, and we expect it to again in the future.
Deals, Deals & More Deals
Global merger and acquisition activity was $959 billion in the first quarter. While this marked an 18% decline from last year’s record $1.2 trillion in the first quarter, it is still the fourth largest opening quarter for M&A activity since records began in 1980. With market rates significantly lower, the Fed no longer tightening, and the trade/global growth scare of last year seemingly behind us, we believe we are again in an environment that should be constructive for M&A activity.
Investment Scorecard
The top contributor to performance during the quarter was Swedish Match (4.8% of net assets as of March 31, 2019) (+30%), which reported a strong fourth quarter, driven by its snus and tobacco-free ZYN products. Industrial companies including Honeywell (2.6%) (+21%), Genuine Parts Company (2.7%) (+18%), Crane Co. (2.1%) (+18%) and Circor (0.8%) (+53%) rebounded from sell-offs in the fourth quarter of 2018 as recession fears waned and hopes for a trade deal with China waxed. Interest rate sensitive firms such as utility National Fuel Gas (3.5%) (+20%) and real estate investment trust Ryman Hospitality (2.1%) (+25%) performed well as Treasury yields declined. Finally, Viacom (5.6%) (+17%) rose as it extended carriage of its networks on one of its largest distributors (AT&T), clearing the path for a potential combination with CBS (6.4%) (+9%).
The largest detractor from performance was Sony (4.5%) (-13%), which declined amid concerns about the prospects of its video game console business as well as negative trends for iPhones (for which it is a supplier) in China, though after the quarter it was reported that activist investor Third Point had taken a stake in the company. Mexican media and telecommunications leader Grupo Televisa (0.9%) (-12%) also detracted from performance as it dashed hopes for a near-term spin-off of its cable operations; concerns also linger around Mexico’s new president and the state of relations with the United States.
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 March 31, 2019.
American Express Co. (AXP, Financial) (3.9% of net assets as of March 31, 2019) (AXP – $109.30 – 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 December 2018, American Express has 114 million cards in force and nearly $82 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) (3.4%) (BK – $50.43 – 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 2018, the firm had $33.1 trillion in assets under custody and $1.7 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.
Fox Corporation (FOX, Financial) (0.7%) (FOX/FOXA – $35.88/$36.71 – NASDAQ) headquartered in New York City, owns a high-quality collection of cable and television networks focused on news and sports content. Fox News remains a powerful brand and the most watched news channel. Given Fox News’ high ratings, live viewing and position as sole provider of conservative-focused news, we expect the company is in an excellent position to demand increased affiliate fees from distributors. While still small, Fox Nation, an OTT news platform meant to serve as an add-on service for highly engaged Fox News viewers. News is typically watched live which should limit cannibalization from SVOD alternatives such as Netflix and Amazon Prime. News viewership in general and Fox news in particular benefit from increased political engagement associated with a more contentious political cycle. We expect Fox News will be a beneficiary of a potentially extended 2020 political cycle. Fox Broadcast Network should benefit from substantial retransmission revenue growth over the next three years (we expect it could generate an incremental $1 billion of contractually recurring retransmission and reverse compensation revenue over that period). The Fox Broadcast Network broadcasts substantially more sports programming than competing networks. The channel features both Sunday and Thursday Night football broadcasts, Major League Baseball, FIFA soccer, NASCAR and United States Golf Association (USGA) events. Fan engagement and live viewing has made sports programming highly valuable to channels in retransmission renegotiations. The spin-off of Fox Corporation was a taxable event which resulted in a step-up in the company’s tax basis. FOX expects to be able to shield $1.5 billion of taxable income per year for 15 years which should result in a net cash benefit of approximately $360 million per year.
Honeywell International Inc. (HON, Financial) (2.6%) (HON – $158.92 – NYSE) operates as a diversified technology company with highly engineered products, including turbine propulsion engines, auxiliary power units, aircraft brake pads, environmental control systems, engine controls, communications and navigation systems, sensors, building automation, catalysts and absorbents and process technology for the petrochemical and refining industries and warehouse automation equipment and software. 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.
Liberty Broadband’s (LBRDK, Financial) (1.5%) (LBRDK/LBRDA – $91.74/$91.64 – NASDAQ) primary asset is a 21% stake in Charter Communications, the second largest cable provider in the U.S. Charter continues to reap the benefits of its 2016 acquisition of Time Warner Cable while growing its residential and commercial broadband subscriber base and consistently shrinking its shares outstanding. Liberty’s Chairman Dr. John C. Malone was a pioneer in the cable industry having built TCI into the country’s largest cable provider before selling to AT&T. Another Malone-related entity, GCI Liberty, owns 24% of Liberty Broadband and 2% of Charter; we believe the two entities are likely to be merged in the medium term.
Newmont Mining Corp. (NEM, Financial) (3.8%) (NEM – $35.77 – NYSE) 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 5.2 million ounces of gold and 120 million pounds of copper in 2018, with approximately 70% of this production coming from the United States and Australia. Newmont undertook company wide cost cutting measures during the period 2013 – 2017, 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. On January 14 Newmont announced that it had reached an agreement to acquire fellow gold miner Goldcorp in a $10 billion stock for stock deal. In acquiring Goldcorp, Newmont is aiming to turn around underperforming assets and establish 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, it is seeking to cement its position as the premier gold investment vehicle in the world.
Republic Services Inc. (RSG, Financial) (4.2%) (RSG – $80.38 – 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 40 states and Puerto Rico. Republic serves more than 2,800 municipalities and operates 190 landfills, 207 transfer stations, 349 collection operations, and 91 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.
Ryman Hospitality Properties Inc. (RHP, Financial) (2.1%) (RHP – $82.24 – NYSE) is the owner/operator of four large convention-centric hotels under the Gaylord brand. It also owns the Opryland brand and entertainment complex in Nashville, the city of its origin. As such, it has benefited from the growth in country music and consumer preference for live entertainment. The company’s hotels are group-focused, and bookings have remained strong due to a steady economic expansion in the United States and limited supply growth within the group-focused hotel market segment. Future growth will come from new hotels (likely established as joint ventures) and investment into existing properties as well as development of live entertainment venues. The company, which is structured as a REIT (real estate investment trust), provides a tax efficient dividend stream underwritten by the consistency of its cash flow. In time, we expect management to unlock addition value by executing a tax-free spin-off of the entertainment business.
Sony Corp. (SNE, Financial) (4.5%) (SNE – $42.24 – NYSE) is a diversified electronics and entertainment company based in Tokyo, Japan. Sony manufactures the PlayStation videogame consoles and games, operates the Columbia film studio and Sony Music entertainment. It also manufactures image sensors, mobile devices, consumer electronics, and mirrorless and professional cameras and holds majority ownership of Sony Financial Services. We expect growth in consoles/game, music and image sensors. We expect operational improvements in consumer electronics and entertainment to generate EBITDA growth through 2020.
Viacom Inc. (VIA, Financial) (5.6%) (VIA – $32.45 – NASDAQ) is a pure-play content company that owns a global stable of cable networks, including MTV, Nickelodeon, Comedy Central, VH1, BET, and the Paramount movie studio. Viacom’s cable networks generate revenue from advertising sales, fixed monthly subscriber fees, and ancillary revenue from toy licensing. We believe a low valuation and M&A potential outweigh the secular risks of cord-cutting.
Conclusion
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 look for catalysts to surface value, such as industry consolidation, financial engineering, new management, regulatory changes, or a change in cash flow allocation. As active stock pickers, we let Mr. Market serve us rather than inform us about a company’s value, and are always on the hunt for bargains.
April 30, 2019
