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Sydnee Gatewood
Sydnee Gatewood
Articles (1385) 

Mario Gabelli's Gabelli Asset Fund 3rd-Quarter Shareholder Commentary

Discussion of markets and holdings

To Our Shareholders,

For the quarter ended September 30, 2019, the net asset value (NAV) per Class AAA Share of The Gabelli Asset Fund decreased 1.0% compared with an increase of 1.7% for the Standard & Poor’s (S&P) 500 Index. Other classes of shares are available. See page 2 for additional performance information for all classes.

Third Quarter Commentary

If you had turned off the news (and Twitter) for the entirety of the third quarter and were told the U.S. stock market was up a little under 2%, just shy of all-time highs, you might assume it was an uneventful quarter. But behind that exceedingly normal quarterly appreciation was a roller-coaster of market, economic and political events.

After climbing in July, stocks fell sharply in August. September saw a slight gain, but beneath the surface many dynamics were at play: momentum stocks declined, and “value” stocks rose sharply, in an abrupt reversal of trends of the last several years. A steady stream of news headlines and world events impacted the market throughout the quarter: the ongoing China/U.S. trade war, Brexit, Saudi oil field attack, central bank easing, yield curve inversion, negative interest rates, U.S. recession concerns, relatively slow growth in China and Europe, and a formal impeachment inquiry of President Trump by Congressional Democrats. On monetary policy, the Federal Reserve confirmed what everyone anticipated: it changed course from its tightening cycle and cut the federal funds rate twice in the quarter (each time by 25 basis points), ending the quarter at 1.75%- 2%. The market is currently expecting further rate cuts in October and December. Treasury yields fluctuated widely, with the 10 year ranging from 2% at the beginning of the quarter, to under 1.5% in early September, to finishing the quarter at 1.7%. As of this writing, yields are now near 1.5%. and stocks have sold off once again.

The U.S. economic picture continues to be relatively solid. GDP was up 2% in the second quarter, following 3.1% growth in the first quarter. The unemployment rate continues to test the lower bound of what many believed possible, falling to 3.5% in September, a 50-year low. That said, there are negative trends in some key indicators, with the PMI falling to 47.8%, showing a contraction in manufacturing, and the ISM falling to 52.6%, indicating slowing growth for the services sector.

Many questions remain for stock market participants: Will the U.S. and China finally agree to a trade deal? Will the Federal Reserve continue cutting, or even become more aggressive in the face of worsening economic data? If so, how quickly would interest rate sensitive businesses start to benefit and economic growth accelerate? Even if President Trump survives impeachment, will controversy and a slumping economy lead him to be voted out 2020? If he does, will the Democratic victor be a relative centrist, or a progressive with an aggressive economic agenda with implications for broad swaths of the economy? The answers to these questions will have real impacts for both the economy and equity values.

While we do not pretend to have unique insight into the outcome of these open questions, we do attempt to build a portfolio of strong businesses that can both survive and even thrive in a wide variety of economic (and political) conditions. These include suppliers of critical components to aerospace manufacturers, providers of media content as well as the broadband by which it is delivered, manufacturers of essential infrastructure products that keep our utilities running and water clean, and producers of food and beverages we consume daily. We continue to buy stocks that trade at discounts to our estimates of Private Market Value with one or more catalysts that can surface that value. We are happy to own attractively valued excellent businesses with the potential to compound value for extended periods of time. As always, we hope for the best outcomes for the economy and stock market but prepare for the worst, and believe (y)our Fund can successfully navigate these volatile times.

Investment Scorecard

Top contributors to performance during the quarter included Sony (2.2% of net assets as of September 30, 2019) (+10%), which did not announce a split-up of its businesses amid investor pressure, but did commit to 200 billion yen of share repurchases and ongoing constructive dialogue with shareholders; Brown-Forman (2.5%) (+8%), which reported flat sales for its fiscal first quarter, a better than expected outcome as it absorbed tariffs on American whiskey in the EU; Aerojet Rocketdyne (1.1%) (+13%), which continues to benefit from increasing spending on both military and commercial aerospace projects; Royal Gold (0.7%) (+22%), which rose in tandem with the increase in the price of gold bullion; and Kikkoman (0.9%) (+9%), which reported an increase in both sales and profits, driven by its domestic food products and beverages, overseas foods, and wholesale divisions.

Detractors from performance included Telephone and Data Systems (1.1%) (-14%), which decline amid investor disappointment that USM is not planning to sell its 4K wireless towers in the near-term, as well as weaker than expected postpaid wireless net subscriber additions; Viacom (0.5%) (-24%), which announced that it agreed to merge with CBS (0.5%) during the quarter, though without a premium for its Class A voting shares; Flowserve (1.1%) (-12%), which declined amid concerns about a potential recession and the corresponding fall in the Brent crude price; and the Walt Disney Company (1.6%) (-7%), which gave back some of its year to date gains ahead of the highly anticipated launch of its Disney+ streaming product.

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 September 30, 2019.

Aerojet Rocketdyne Holdings Inc. (NYSE:AJRD) (1.1% of net assets as of September 30, 2019) (AJRD – $50.51 – NYSE) (Cv., 2.25%, 12/15/2023) ), 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. These convertible bonds provide a lower volatility way to invest in AJRD. The bonds provide a reasonable yield, where the stock does not pay a dividend.

American Express Co. (NYSE:AXP) (1.3%) (AXP – $118.28 – 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 September 2019, American Express has 114 million cards in force and nearly $84 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.

AMETEK (NYSE:AME) (2.8%) (AME – $91.82 – NYSE) is a diversified supplier of highly engineered equipment used in a broad array of industrial end markets. The company offers a diverse product portfolio including test and measurement, metrology, and precision motion control equipment in addition to specialty materials and aftermarket services. Organic sales growth has remained strong thus far this year, up 4% year-over-year in the first half of 2019 and the company finished June with a near record backlog of $1.7 billion. After spending a total of $1.1 billion acquiring six businesses in 2018, AMETEK still had $567 million of cash and $1.5 billion of availability on its revolving credit facility as of June 2019 that it expects to deploy on additional acquisitions. The company has begun to target software and Internet of Things-based businesses that will allow AMETEK to leverage the vast amounts of measurement and instrumentation data that it collects for customers to provide more recurring, service-based offerings.

Brown-Forman Corp. (NYSE:BF.A)(BF.B) (2.5%) (BFA/BFB – $59.75/$62.78 – NYSE) is a leading global distilled spirits producer. Spirits is an advantaged category that enjoys high margins, low capital requirements, strong free cash flow generation, and good pricing power. The company’s global brands include Jack Daniel’s Tennessee whiskey, Finlandia vodka, Woodford Reserve bourbon, and el Jimador and Herradura tequilas. Jack Daniel’s is one of the world’s most valuable spirits brands, enjoying strong growth both in the U.S. and internationally as consumers increasingly choose to drink American whiskies. The company has also successfully expanded the brand into the fast growing flavored whiskey category. While Brown-Forman does face some near term headwinds from ongoing trade disputes, emerging market sales have returned to growth, and the company is positioned to grow revenues and profits substantially over the next several years, and has significant balance sheet flexibility. While the company is family controlled, we believe that if it ever became available for sale it would be highly coveted by other large global spirits players.

Diageo plc (NYSE:DEO) (1.8%) (DEO – $163.52 – NYSE) 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.

Madison Square Garden Co. (NYSE:MSG) (1.6%) (MSG – $263.52 – NYSE) 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. In June 2018, the company announced that it was likely to spin-off of its teams, which we think could further surface value, especially as MSG expands its portfolio to include Spheres venues in Las Vegas and London.

Mastercard Inc. (NYSE:MA) (1.6%) (MA – $271.57 – NYSE) is one of the largest electronic payments processing companies, providing services in more than 210 countries and territories. It continues to capitalize on the strong secular global trend of moving to electronic payments from traditional paper. For all of 2018, clients charged approximately $4.3 trillion. At the end of June 2019, cards in force totaled over 2.1 billion. Longer term, we believe, MasterCard is well positioned to increase revenue due to global growth in personal incomes, rapid increase in commerce, and movement to electronic payments.

Republic Services Inc. (NYSE:RSG) (1.8%) (RSG – $86.55 – 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 41 states and Puerto Rico. Republic serves more than 2,800 municipalities and operates 190 landfills, 210 transfer stations, 349 collection operations, and 88 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. (NYSE:SNE) (2.2%) (SNE – $59.13 – NYSE) is a conglomerate based in Tokyo, Japan focusing on direct-toconsumer entertainment products supported by the company’s technology. Sony is the #1 integrated global gaming company and we expect the gaming segment to contribute over 1/3 of total EBITDA (ex-financial) in 2020 following the launch of the PlayStation 5. Sony Music Recording commands #2 and Music Publishing #1 global share. Sony also operates the Sony/Columbia film studio, It is an image sensor leader with over 50% global revenue share and is the dominant supplier to Apple iPhone. Sony’s Electronics business is a globally diversified cash cow. It also holds majority ownership of Sony Financial Services. We expect flat EBITDA in 2019 increasing 8% in 2020 and 10% in 2021 as the gaming division turns, the music business continues to benefit from the growth of streaming and the Film Studio rebounds.

Swedish Match AB (OSTO:SWMA) (1.5%) (SWMA – $41.35/SEK407.10 – Stockholm Stock Exchange) produces tobacco products that include snus and snuff, chewing tobacco, cigars, and lights. The company has been benefiting from the growth of the smokeless tobacco market in both Scandinavia and the U.S., as public smoking bans and health concerns are driving consumers to seek alternative tobacco products to cigarettes. In October 2010, Swedish Match combined its European and premium cigar portfolios with Scandinavian cigar and pipe tobacco company STG, creating a new company that should benefit from enhanced scale and synergies. In February 2016, STG went public via an IPO on the Copenhagen Stock Exchange, with Swedish Match fully exiting its stake by 2017. The company has a tobacco-free nicotine pouch product called ZYN that is growing rapidly in the U.S. and Scandinavia, and is driving growth in its mass market cigar business through its new natural leaf products. In October, the company’s General Snus brand was deemed a modified risk tobacco product (MRTP) by the FDA. We expect Swedish Match to continue to grow its cigar and smokeless business globally, and the company could be an attractive takeover candidate for a global tobacco company that wants to increase its presence in the smokeless segment.

November 8, 2019

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.

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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