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Sydnee Gatewood
Sydnee Gatewood
Articles (1320) 

Keeley Mid Cap Dividend Value Fund's 3rd-Quarter Commentary

Discussion of markets and holdings

October 10, 2019 | About:

To Our Shareholders:

For the quarter ended September 30, 2019, the Keeley Mid Cap Dividend Value Fund’s net asset value (“NAV”) per Class A share rose 1.32% compared with a 1.22% gain for the Russell Midcap Value Index. Year-to-date, the Fund is up 17.36% compared with a 19.47% gain for the benchmark.

Commentary

Summer is usually a fairly quiet time of year, but the third quarter was anything but quiet. While the market was relatively calm, the cross-currents in the economy and on the political landscape continue to make the outlook cloudy. The trends from last quarter continued as we saw another Fed rate cut, the trade conflict between the U.S. and China churned on, and growth in economies around the world slowed. On the positive side, consumer confidence, as measured by the University of Michigan’s Consumer Sentiment Index, remained steady in July before dropping in August and then strengthening in September. Gains in jobs and incomes helped to offset some of the uncertainty over trade issues. Other positive signs for the U.S. economy included strong growth in housing starts and the labor force participation rate ticked up in August to 63.2% -- a level that matches recent highs posted in early 2019. Meanwhile, some less-encouraging data included lackluster job gains in August, with nonfarm payroll growth well below expectations. In addition, ISM U.S. manufacturing Purchasing Managers’ Index declined for a second straight month in September and the 47.8% reading was the lowest since June 2009.

Two issues that had been simmering on the back burner moved forward during the quarter, one domestic and one international. The domestic issue is the effort in the House of Representatives to impeach President Trump. There is no question that impeachment would introduce to the market yet another element of uncertainty. The international issue involves the recent attack on a major Saudi oil production facility.

The equity market, as measured by the S&P 500 Index, was up 1.2% in the third quarter and is now up 18.7% through the year’s first nine months. Larger cap stocks continue to outperform small caps, with the Russell 1000 Index gaining 1.4%, in the quarter, while the Russell 2000 Index lost 2.4% and the Russell Midcap Index landed in between with a 0.5% gain. For the first time this year, Value outperformed growth, although it did so only in small cap and mid cap. Large cap growth stocks continue to beat large cap value stocks and were the best performing style category.

Meanwhile, bond market yields continue to fall with the 3-month US Treasury bill yield falling 24bps to 1.88% and the 10-year bond falling 32bps to 1.68%. The yield curve inverted in the second quarter for the first time since 2007 and remained inverted in the third quarter. In the commodities markets, gold was up 2.8%. Oil fell 3.0% in the quarter.

When the year began, we were optimistic about the outlook for the market. The fourth quarter 2018 market slump had lowered valuations to a very attractive level. Furthermore, we thought the factors that led to the fall (trade wars and the government shutdown), would be resolved. The government shutdown was short-lived, but the trade conflict lingers. The trade disputes had led to some of the softness in the economic numbers in the U.S. and abroad. Over this same time period, the market has been strong with solid double-digit gains across the board. As a result, valuations have moved up, but the only segment where valuation is below its long-term average is small-cap value, while mid-cap value is a little above its long-term average.

Portfolio Results

We are pleased to report that the Keeley Mid Cap Dividend Value Fund outpaced its benchmark in the quarter, representing an improvement from the performance in the first half of the year.

Sector Allocation and Stock Selection were both positive contributors to performance, The Selection impact was positive in four sectors and negative in four and a push in the other three. The best-performing sectors were the Materials, Health Care and Communication Services sectors, with good contributions from the Consumer Staples sector as well. The sectors that lagged the most were Financials, Energy, and Utilities.

Gains in the Materials sector were broad-based, with five of the Fund’s six holdings significantly outperforming the index. The top contributors there were Vulcan Materials and RPM International, both of which posted strong revenue and earnings growth, and Huntsman Corporation.

Although the Health Care sector was negative for the quarter – owing to continued fears of greater government influence on several aspects of the industry – the Fund posted a positive return in the sector. The gains were led by Universal Health Services, but each of the Fund’s five holdings outperformed the sector.

The Communication Services sector is another sector where the index posted negative performance for the quarter, but the Fund returned close to 9%. Both of the Fund’s stocks in the sector, Cinemark Holdings and Nexstar Media Group, posted solid gains.

The Consumer Staples sector was the third best performing sector in the benchmark, but the Fund’s Consumer Staples holdings performed even better. Packaged foods company Conagra Brands and leading French fry producer both generated double-digit gains in the quarter.

The Financial sector was the largest detractor on a relative basis for the Fund during the third quarter. The weakness was most pronounced at Virtu Financial, which declined almost 24% owing to diminished market volatility, which is a leading driver of profitability for the firm.

Energy was the weakest sector in the Russell Midcap Value Index in the quarter and the Fund’s holdings did even worse. Natural gas companies Cabot Oil & Gas and EQT led the way down on weaker natural gas prices. Because both stocks were amongst the Fund’s biggest detractors, we discuss them below in the Let’s Talk Stocks section.

The Utilities sector was the second-best performing sector in the Russell Midcap Value index. While the Fund’s holdings in the sector performed well, they did not keep up. The primary reason for this was the 10% decline in National Fuel Gas. The company is not only a gas utility, it is also a natural gas producer and, as we noted in the last paragraph, that was not a good place to be.

During the quarter, the Fund added five new positions and one holding was converted due to a merger (Total System Services was acquired for stock by Global Payments).

Let’s Talk Stocks

The top three contributors in the quarter were:

Sabra Health Care REIT (NASDAQ:SBRA) (SBRA - $22.96 – NASDAQ) is a Healthcare REIT focused on Skilled Nursing facilities (SNF) and Assisted Living and Independent Living facilities. The market rewarded Sabra’s second quarter of in-line results as the company has been plagued by missteps and industry woes since the acquisition of Care Capital Properties in August 2017. Investors are starting to become comfortable with management’s focus on fixing the credit quality of the company by cleaning up the portfolio and improving the balance sheet to maintain investment grade ratings. Underlying trends remain favorable and with management’s focus shifting back towards growth should continue to help close the significant valuation gap with peers.

Brixmor Property Group (NYSE:BRX) (BRX - $20.29 – NYSE) is a real estate investment trust that owns grocery-anchored shopping centers. The company has been in the midst of a multiyear transformation aimed at sharpening its portfolio. These efforts have included reducing the number of markets in which the company operates, increasing the number of redevelopments that it is undertaking and swapping out certain anchor tenants for better ones. During the quarter, Brixmor shares outpaced broader REITs as investors became bigger believers in Brixmor’s accelerating rental income and profit growth in the coming quarters. The company’s healthy 6% yield also has drawn some investor interest.

Vulcan Materials Company (NYSE:VMC) (VMC - $151.24 – NYSE) is a leading producer of aggregates and other construction materials (asphalt, concrete, and calcium) for use in infrastructure and buildings. The company reported an excellent quarter despite significant weather headwinds posting double-digit revenue and EPS growth. Aggregate pricing environment remains very robust and management expects an improvement in the asphalt segment as input costs moderate. The outlook remains very positive as end-markets remain strong with continued strength in aggregate pricing. Outlook could improve further if there is any progress in Washington on a new Federal Highway bill.

The three largest detractors in the quarter were:

DXC Technology (NYSE:DXC) (DXC - $29.50 – NYSE) is one of the world’s largest providers of information technology services. DXC saw several setbacks in the quarter which drove the share price lower. The first was disappointing fiscal first quarter financial results. While the company has done an admirable job cutting costs, it has been unable to stem its revenue declines. It also lowered its full fiscal year (ends March) outlook. The second setback was the retirement of CEO Mike Lawrie. While new CEO Mike Salvino comes with an excellent track record and is probably better suited to lead the company at this stage of its evolution, concerns arose that new management may have to ramp up spending in order to stabilize revenue growth.

EQT Corporation (NYSE:EQT) (EQT - $10.64 – NYSE) is a natural gas focused exploration and production company operating in Appalachia. The company experienced a highly visible proxy fight in early July which resulted in dissident shareholders taking control of the board and executive suite. While we were supportive of the winning side in this fight, it appears investors are thinking changes to the cost structure may take longer than expected to realize especially after the new management reduced headcount a month after taking over.

Cabot Oil & Gas (NYSE:COG) (COG - $17.57 – NYSE) is one of the lowest cost producers of natural gas in North America. Investors were spooked at capital spending which came in above expectations when the company reported 2Q19 results. However, the reasoning for the higher Capex was for the company to acquire adjacent acreage enabling COG to drill longer laterals at superior economics. Furthermore, this is a company already returning cash to shareholders at a time when few industry participants can.

Conclusion

In conclusion, thank you for your investment in the KEELEY MidCap Cap Dividend Value Fund. We will continue to work hard to justify your confidence and trust.

This summary represents the views of the portfolio managers as of 09/30/19. Those views may change, and the Fund disclaims any obligation to advise investors of such changes. For the purpose of determining the Fund's holdings, securities of the same issuer are aggregated to determine the weight in the Fund. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual securities.

About the author:

Sydnee Gatewood
I am the editorial director at GuruFocus. I have a BA in journalism and a MA in mass communications from Texas Tech University. I have lived in Texas most of my life, but also have roots in New Mexico and Colorado. Follow me on Twitter! @gurusydneerg

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