MGRD - Longleaf Partners Fund Q3 2023 Commentary

2023-10-15 10:45:00 ET

Summary

• Longleaf Partners Funds is a suite of mutual funds and UCITS funds that Southeastern Asset Management, the investment advisor to the Longleaf Partners Funds, created in 1987 as a way for Southeastern employees to invest alongside their clients.
• Longleaf Partners Fund outperformed the S&P 500 and Russell 1000 Value in the third quarter, despite a challenging market.
• The fund does not hold exposure to mega-cap stocks that are trading at historic valuation multiples.
• The fund's top performers in the quarter were CNX Resources, Warner Music Group, and Mattel, while IAC and Warner Bros Discovery were detractors.

Longleaf Partners Fund declined -1.82% in the third quarter, holding up better than the S&P 500 and Russell 1000 Value, which fell -3.27% and -3.16%, respectively in a challenging, “risk-off” period. Most of our companies saw solid operational progress, translating into positive stock performance at some of our larger positions in a quarter when only Energy and Communication Services were positive absolute sectors for the S&P 500 ( SP500, SPX ).

The Partners Fund has no exposure to the small handful of mega-cap stocks that have dominated the market and are trading at historic valuation multiples. Many headlines refer to the “Magnificent Seven,” but we prefer to look at the top 11 most actively traded stocks globally, all of which are in the US. These 11 stocks (comprised of the Magnificent Seven + Advanced Micro Devices, Adobe, Broadcom and Netflix) have a combined market cap of just over $11 trillion and a weighted average price to earnings ratio (P/E) of 29x, while the rest of the S&P 500 trades at approximately 15.5x. These already huge companies are facing increased competition against one another coming off all-time-high aggregate profits on the back of increased interest rates. By contrast, Partners Fund owns high-quality businesses, led by management teams that are executing across the board, and the portfolio trades at 13x P/E on not yet optimized earnings, even after returning 25% over the last 12 months. We are confident in the portfolio’s positioning for future relative outperformance in multiple market environments.

We encourage you to watch our video with Portfolio Managers Ross Glotzbach and Staley Cates for a more detailed review of the quarter.

Contribution To Return As Of September 30, 2023

• CNX Resources – Natural gas company CNX Resources was the top performer in the quarter. The company benefited from rising energy prices, as well as strong operational execution. CNX remains highly discounted, as the market does not give the company credit for its longer-term undrilled assets or its “new technology investments”, which include methods to reduce carbon on a net basis. Management expects this to be a material business for CNX over the longer term, but for now it is a high-quality hidden asset. CNX has taken advantage of the price disconnect through meaningful share repurchase.
• Warner Music Group – Global music entertainment company Warner Music Group ( WMG ) was another positive contributor in the quarter. The company reported an improved streaming growth rate back in line with long-term expectations, recovering from a disappointing 1Q. Even more meaningful for the long term, digital service providers (DSPs), including Spotify, finally implemented pricing increases for streaming services with no signs of increased churn. WMG CEO Robert Kyncl called it “an encouraging start” and highlighted the potential for significant upside if audio streaming follows video streaming pricing.
• Mattel – Global toy and media company Mattel contributed in the quarter on the back of the success of the Barbie movie. Beyond the near-term positive financial impact, the Barbie movie is emblematic of Ynon Kreiz’s plan to monetize the strong intellectual property that the company owns. When we interviewed Kreiz on the Price - to - Value Podcast in June 2020 , he said, “Barbie is so much more than a toy. Barbie at this point is a cultural phenomenon, and the consumers have a very strong emotional connection with our brands.” We expect Mattel to continue to monetize more of its strong brands in ways beyond selling toys.
• IAC – Digital holding company IAC was the largest detractor in the quarter after reporting weak earnings, particularly at underlying holding Angi, which represents a relatively small (single-digit %) proportion of the value but has an outsized impact on IAC’s stock price. Casino and online gaming company MGM Resorts (which we also own directly and was a detractor in the quarter) comprises the largest portion of the IAC value. MGM faced multiple headwinds this quarter with a cyberattack that impacted all its properties and pending labor strikes in Las Vegas. Even with these events factored into our appraisal, MGM remains highly discounted today, and management is taking advantage of the price weakness to add value through meaningful share repurchase. Dotdash Meredith should begin showing its true earnings power as synergies of the merger begin to materialize. IAC is focused on growing the value of its hidden assets, like Care.com and Turo, which might go public later this year. IAC is well positioned with a net cash balance sheet to go on offense in any kind of market environment and offers a meaningful margin of safety and upside opportunity from today’s depressed level.
• Warner Bros Discovery – Media conglomerate Warner Bros Discovery ( WBD ) declined in the quarter with a combination of the writers’ and actors’ strikes headlines, and a fight between Charter and Disney that led to more concerns about the linear and streaming profit structure. Although both situations actually improved as the quarter went on, both created uncertainty that weighed heavily on the WBD stock price in the near term. The underlying business is executing better, with solid free cash flow generation reported in the quarter that should continue for the foreseeable future. The competitive landscape is getting brighter with multiple streamers taking price increases. WBD is in the hands of a strong management team and board that are focused on creating long-term value for shareholders.

Portfolio Activity

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