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Holly LaFon
Holly LaFon
Articles (10163)  | Author's Website |

John Rogers' Ariel Fund 2nd Quarter Commentary

Discussion of markets and holdings

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, 2019, the average annual total returns of Ariel Fund (Investor Class) for the 1-, 5-, and 10- year periods were -0.72%, +6.71%, and +15.14%, respectively. For the year ended September 30, 2018, the Fund’s Investor Class shares had an annual expense ratio of 1.01%.

Quarter Ended June 30, 2019

Confronted by weaker economic data, trade uncertainty and rising concerns about the potential for a broad slowdown in the global economy, central banks came to the rescue in the second quarter by signaling further monetary stimulus in the months ahead. This development helped propel large cap stocks to record highs, while smaller company issues lagged behind. Meanwhile, earnings growth abroad continues to be challenged by uncertainties surrounding Brexit, political risks and cooling economic momentum. For the quarter, Ariel Fund increased +0.77%, trailing the Russell 2500 Value Index and the Russell 2500 Index, which returned +1.89% and +2.96%, respectively.

Several stocks in the portfolio had strong returns in the quarter. Leading global floor product manufacturer, Mohawk Industries, Inc. (NYSE:MHK) posted a +16.90% gain on financial results that were in line for the second consecutive quarter, however forward looking guidance fell short of expectations. Nonetheless, MHK exhibited sequential improvement in organic growth as well as reduced production rates to balance inventory with customer demand and to manage working capital. In an effort to further address its present operating environment, MHK put through a price increase to offset higher energy and materials as well as consolidated inefficient operations, enhanced manufacturing processes and reduced overhead expenses. Furthermore, the company continues to introduce new products to differentiate its offerings and enhance margins. We have confidence in this owner-operated management team and believe that moderating cyclical headwinds support an improving growth/margin cadence. At current levels, MHK is trading at a 40% discount to our estimate of private market value.

Additionally, leading manufacturer of building and construction solutions Simpson Manufacturing Co., Inc. (NYSE:SSD) advanced +12.55% in the period. SSD continues to make progress executing on initiatives that are focused on growing market share, rationalizing cost structure to drive improved profitability and enhancing its technology infrastructure. In our view, many underlying factors support a normalized level in U.S. housing starts which would enable an increase in demand for SSD’s products, including strong consumer confidence, low unemployment rates, declining interest rates and a low level of housing stock availability.

Alternative asset manager, KKR & Co. Inc. (NYSE:KKR) also outperformed in the period, trading +8.13% higher, as the company’s financial results continue to highlight strong underlying fundamentals. KKR has also simplified its public reporting with a focus on distributable earnings as its primary metric. In our view, simplified reporting along with the company’s conversion to a corporation from a partnership has broadened investor appeal, while attracting more long-term oriented shareholders.

Alternatively, there were a few notable performance detractors in the quarter. Producer and supplier of sand, U.S. Silica Holdings, Inc. (NYSE:SLCA) traded -25.87% lower. We view this overall price decline to run counter to the company’s strong business fundamentals. Specifically, SLCA delivered another solid earnings report highlighted by record results from the Sandbox Logistics unit; a strong quarter from the Industrial business; and better than expected results from the Oil and Gas business due to a resurgence in both volumes and pricing for Northern White sand. Moreover, management believes this momentum will continue. Key components of our investment thesis are the less volatile Industrial segment business unit and the positioning of SLCA’s Sandbox Logistics business. Given current trends and management’s bullish outlook in these areas, we continue to believe the company remains well positioned from a risk/reward standpoint.

Waste management services provider, Stericycle, Inc. (NASDAQ:SRCL) also detracted from performance, falling - 12.26% in the period. Despite an earnings shortfall relative to Wall Street estimates, the financial results were relatively in line with management’s expectations. As such, SRCL reiterated its confidence in the business and reaffirmed full year guidance. The company expects quarterly revenue and profits to improve sequentially throughout 2019, driven by seasonality and initiatives the new management team is implementing to increase sales, improve profitability and reduce costs. Looking ahead, we continue to view SRCL as solid franchise with stable long-term growth prospects, including margin expansion opportunities and strong free cash flow generation resulting from ongoing strategic transformation initiatives.

Lastly, toy manufacturer, Mattel Inc. (NASDAQ:MAT) declined - 13.77% in the quarter, as a voluntary product recall and trade tensions weighed on shares. Nonetheless, we continue to believe management is making meaningful progress on its multi-year turnaround plan. MAT delivered another earnings beat, highlighted by solid top-line performance and a significant improvement in profitability. In addition, the company is on track to deliver more cost savings than originally targeted, which excludes efficiencies gained through supply chain optimization. Furthermore, the announcement of several new licensing deals and movie agreements for some of its iconic brands in the quarter provide evidence that MAT is also executing on goals to capture the full value from its intellectual property in the mid-to-long term. At today’s valuation, we see the risk/reward skewed sharply to the upside.

While we did not initiate any new positions in the quarter, we successfully sold out of Oaktree Capital Group, LLC (NYSE:OAK), as the company announced it was being acquired by Brookfield Asset Management (NYSE:BAM). In addition, we exited our position in Bristow Group, Inc. (BRS) to pursue more compelling opportunities.

We remain cautiously optimistic that slowing yet steady U.S. economic and corporate earnings growth will continue to generate positive returns for quality companies with strong balance sheets in this late-cycle environment. That said, short-term corrections and market volatility are expected in the near-term—be it from profit taking, corporate earnings swings, elevated corporate debt leverage, trade policy or geopolitical factors. And while meaningful to current market sentiment and conversation, we view these uncertainties and risks as short-term noise within the context of our long-term investment horizon.

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.

As of 06/30/2019, Mohawk Industries, Inc. constituted 3.6% of Ariel Fund; Simpson Manufacturing Co., Inc. 2.9%; KKR & Co., Inc. 4.6%; U.S. Silica Holdings, Inc. 3.3%; Stericycle, Inc. 2.9%; and Mattel, Inc. 3.4%. Portfolio holdings are subject to change. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of Ariel Fund.

About the author:

Holly LaFon
I'm a financial journalist with a Master of Science in journalism from Medill at Northwestern University.

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