ISFFF - Vulcan Value Partners Q3 2023 Letter
2023-10-12 08:50:00 ET
Summary
- Vulcan Value Partners are value investors - business analysts with a long-term time horizon focused on purchasing publicly traded companies that are competitively entrenched at significant discounts to intrinsic worth.
- All five strategies produced negative returns in the third quarter, but short-term results are not given much weight.
- Large Cap Review: Purchased four new positions and exited one position. Diageo, Marriott, Texas Instruments, and UnitedHealth Group are highlighted.
- Small Cap Review: Exited one position and had both material contributors and detractors. MillerKnoll and Ituran Location and Control performed well, while ISS and SmartRent faced challenges.
PORTFOLIO REVIEW
All five of our strategies produced negative returns for the third quarter. These results are detailed in the table below. As we have often said, we place no weight on short-term results, good or bad. When we think we can improve our prospective long-term returns and lower risk, we will make those decisions without regard to their effect on short term performance.
| Since Inception* |
| Large Cap Composite (Gross) |
| -4.1% |
| 20.6% |
| 9.1% |
| Large Cap Composite ((Net)) |
| -4.2% |
| 20.1% |
| 8.3% |
| Russell 1000 Value Index |
| -3.2% |
| 1.8% |
| 6.3% |
| -3.3% |
| 13.1% |
| 9.1% |
| Small Cap Composite (Gross) |
| -5.5% |
| 7.0% |
| 7.9% |
| Small Cap Composite ((Net)) |
| -5.7% |
| 6.4% |
| 6.9% |
| Russell 2000 Value Index |
| -3.0% |
| -0.5% |
| 5.4% |
| Russell 2000 Index |
| -5.1% |
| 2.5% |
| 6.4% |
| Focus Composite (Gross) |
| -1.8% |
| 31.6% |
| 13.0% |
| Focus Composite ((Net)) |
| -1.9% |
| 31.2% |
| 11.9% |
| Russell 2000 Value Index |
| -3.2% |
| 1.8% |
| 6.6% |
| Russell 2000 Index |
| -3.3% |
| 13.1% |
| 9.1% |
| Focus Plus Composite (Gross) |
| -1.9% |
| 31.5% |
| 12.4% |
| Focus Plus Composite ((Net)) |
| -2.0% |
| 30.6% |
| 11.3% |
| Russell 1000 Value Index |
| -3.2% |
| 1.8% |
| 6.3% |
| S&P 500 Index |
| -3.3% |
| 13.1% |
| 9.1% |
| All Cap Composite (Gross) |
| -4.8% |
| 18.3% |
| 9.6% |
| All Cap Composite ((Net)) |
| -4.9% |
| 17.7% |
| 8.6% |
| Russell 3000 Value Index |
| -3.2% |
| 1.7% |
| 9.0% |
| Russell 3000 Index |
| -3.3% |
| 12.4% |
| 11.5% |
| *Inception date is 3/31/2007 for Large Cap, Small Cap, and Focus Plus Composites. Inception date is 11/30/2007 for Focus Composite. Inception date is 4/1/2011 for All Cap Composite. Past performance is no guarantee of future results. Please see important disclosures at the end of this document. Please reference additional performance information for each of the composites in the strategy reviews that follow and important disclosures at the end of this document. In the discussion that follows, we generally define material contributors and detractors as companies having a greater than 1% impact on the portfolio and should be viewed in context with the performance information provided. The specific securities identified and described are not representative of all the securities purchased, sold, or recommended for client accounts. It should not be assumed that an investment in the securities identified has or will be profitable. Actual holdings may vary for each client and there is no guarantee that a particular client’s account will hold all of the securities listed. |
Large Cap Review
| INVESTMENT STRATEGY (As of 09/30/2023) |
| QTD |
| YTD |
| 1 YEAR |
| 3 YEAR |
| 5 YEAR |
| 10 YEAR |
| Since Inception (03/31/2007) |
| Large Cap Composite (Gross) |
| -4.1% |
| 20.6% |
| 30.7% |
| 2.9% |
| 4.9% |
| 8.4% |
| 9.1% |
| Large Cap Composite ((Net)) |
| -4.2% |
| 20.1% |
| 29.9% |
| 2.3% |
| 4.3% |
| 7.8% |
| 8.3% |
| Russell 1000 Value Index |
| -3.2% |
| 1.8% |
| 14.4% |
| 11.1% |
| 6.2% |
| 8.4% |
| 6.3% |
| S&P 500 Index |
| -3.3% |
| 13.1% |
| 21.6% |
| 10.2% |
| 9.9% |
| 11.9% |
| 9.1% |
We purchased four new positions: Diageo plc ( DEO ), Marriott International Inc. ( MAR ), Texas Instruments Inc. ( TXN ), and UnitedHealth Group Inc ( UNH ). We exited one position during the quarter: Lam Research Corp.
There were no material contributors to performance and no material detractors.
Diageo is a global spirits and beer producer with over 200 brands, including Johnnie Walker, Crown Royal, Guinness, Smirnoff, Baileys, Don Julio, and Casamigos. Diageo’s spirits segment generates more than 80% of the company’s revenue, and the spirits segment has been taking share from beer and wine over the last decade. The company is diversified across geographies, brands, and alcohol categories. Diageo has strong margins and high returns on invested capital. Its management team has an excellent track record for brand and product innovation, moving into high-growth categories at the right time. The company has pricing power and performs well during recessions. Additionally, the premiumization trend has been a tailwind to Diageo’s revenue, and we believe this trend will continue, driven by an expanding global middle class and preference for higher quality spirits.
Marriott is a company that we have owned several times in the past. The company is an asset-light global lodging franchisor and operator that benefits from strong network effects. Approximately 99% of Marriott’s global rooms are managed or franchised which enables the company to generate high returns on capital. Marriott has an extensive portfolio of brands ranging from luxury brands such as The Ritz-Carlton, to premium brands such as Westin Hotels & Resorts, to select brands such as Residence Inn by Marriott. The company is doing an excellent job converting independent hotels into the Marriott system through its soft brands including the Luxury Collection, the Autograph Collection, and the Tribute Portfolio. This conversion opportunity should benefit Marriott’s net unit growth in a period when new hotel development could be challenging in North American and Europe. The company generates robust free cash flow through its long-term, contracted franchise fee and management fee revenue streams. Its competitive advantages include brand strength, operational scale, direct booking systems, and loyalty programs. We sold Marriott in the first quarter of 2020 because of our concerns about the company’s debt structure. Since then, Marriott has restructured its debt and improved its balance sheet. Additionally, average daily rates (ADR) on corporate travel have returned to pre-Covid levels.
Texas Instruments is the world’s largest designer and manufacturer of analog semiconductors. These semiconductors convert real-world signals, such as temperature, pressure, and sound, into digital data. Analog semiconductors are also used to manage power in electronic devices. We are drawn to this company because its products are mission critical, and product cost as a percentage of total system cost is low. Moreover, market positions are stable over long periods of time and barriers to entry are high. Its management team thinks strategically, in terms of decades, and focuses on maximizing free cash flow per share over the long term.
UnitedHealth Group is the largest health insurer in the country and also owns Optum, which is a rapidly growing healthcare services company. The health insurance business benefits from demographic and network effects as more members attract more providers and vice versa, which reinforces United’s value proposition and bargaining power with each side of the network. Over the last five years, Optum has grown significantly and roughly half of United’s 2022 EBIT was generated from the Optum business. Optum Health provides care for 102 million consumers and serves more than 100 health payer partners. We expect Optum to continue to grow and be a significant contributor to UnitedHealth Group’s future successes.
We have owned all four of these businesses in the past and are pleased to own them once again in the portfolio.
Lam Research ( LRCX ) designs and manufactures equipment used in the fabrication of semiconductors. Lam is a wonderful business with great long-term prospects. The company has shown tremendous financial resilience against what is currently a challenging industry backdrop. After a significant increase in its stock price over the last year, our margin of safety narrowed. We followed our discipline and sold our position to reallocate capital into businesses with larger discounts.
Small Cap Review
| INVESTMENT STRATEGY (As of 09/30/2023) |
| QTD |
| YTD |
| 1 YEAR |
| 3 YEAR |
| 5 YEAR |
| 10 YEAR |
| Since Inception (03/31/2007) |
| VVP Small Cap (Gross) |
| -5.5% |
| 7.0% |
| 19.1% |
| 7.8% |
| 0.6% |
| 5.0% |
| 7.9% |
| VVP Small Cap ((Net)) |
| -5.7% |
| 6.4% |
| 18.2% |
| 7.0% |
| -0.2% |
| 4.2% |
| 6.9% |
| Russell 2000 Value Index |
| -3.0% |
| -0.5% |
| 7.8% |
| 13.3% |
| 2.6% |
| 6.2% |
| 5.4% |
| Russell 2000 Index |
| -5.1% |
| 2.5% |
| 8.9% |
| 7.2% |
| 2.4% |
| 6.6% |
| 6.4% |
We did not purchase any positions during the quarter. We exited one position during the quarter: Forward Air Corp ( FWRD ).
There were two material contributors to performance: MillerKnoll Inc. ( MLKN ) and Ituran Location and Control Ltd ( ITRN ). There were two material detractors: ISS A/S ( ISSDY ) and SmartRent Inc. ( SMRT )
During the quarter we sold Forward Air. The company announced its decision to acquire Omni Logistics for an enterprise value of $3.2 billion. The transaction will significantly increase leverage at the pro forma company and will materially dilute existing shareholders. We also think that the transaction has questionable strategic rationale and significant execution risk. In sum, the transaction not only reduced our estimate of intrinsic value per share, but made that estimate unstable, leading to our decision to exit the position.
MillerKnoll is a designer and manufacturer of premium furniture for the office and home. While there continues to be a fair amount of uncertainty as it relates to the future of office, the company performed well during the quarter due to strong execution, cost containment, and an indication from management that a positive inflection point in demand is in its sights. We continue to favor the quality of MillerKnoll’s collection of brands, its multi-channel distribution model, and its experienced management team.
Ituran is an Israeli-based company that provides telematics services such as stolen vehicle recovery and usage-based insurance to insurance companies and individual car owners. While nothing material has changed during the past quarter, the company’s growth initiatives continue to bear fruit and the intrinsic value continues to compound. We are happy with the progress the company is making and it remains an attractive price to value opportunity in the portfolio.
ISS is a facilities management company based in Denmark specializing in services that are non-core to their customers such as cleaning, food management, building maintenance, security, technical support, and other services. During the quarter, the CFO, Kasper Fangel, became the CEO. The prior CEO left to become CEO at the much larger brewer Carlsberg Group. The company also announced its plans to exit its struggling French operations. ISS has global scale to service multinational accounts and is benefitting from the trend of companies outsourcing non-core functions. The company has stable operating margins due to the inherent nature of its business contracts which allow it to pass through wage and other cost increases to its customers.
SmartRent provides hardware and software that enables apartment owners to offer digital services to renters. For instance, their software allows apartment operators to control access, provide self-guided tours, and parking management to name a few of their services. Their products lower operating costs for apartment owners and improve their renters’ experience enabling the owners to charge higher rents. During the quarter, we believe the stock price decreased in response to a short report that was published. Through our research, we believe the report to be unfounded and misleading. SmartRent’s products offer a strong value proposition for its customers. The company has a significant and growing backlog with current installations only representing about 10% of the existing customer opportunity.
Focus Review
| INVESTMENT STRATEGY (As of 09/30/2023) |
| QTD |
| YTD |
| 1 YEAR |
| 3 YEAR |
| 5 YEAR |
| 10 YEAR |
| Since Inception (03/31/2007) |
| VVP Focus (Gross) |
| -1.8% |
| 31.6 % |
| 41.7 % |
| 11.1 % |
| 15.6 % |
| 14.2% |
| 13.0 % |
| VVP Focus (Net) |
| -1.9 % |
| 31.2 % |
| 41.1 % |
| 10.6 % |
| 15.0 % |
| 13.5% |
| 11.9 % |
| Russell 1000 Value Index |
| -3.2 % |
| 1.8% |
| 14.4% |
| 11.1% |
| 6.2% |
| 8.4% |
| 6.6% |
| S&P 500 Index |
| -3.3 % |
| 13.1% |
| 21.6% |
| 10.2% |
| 9.9% |
| 11.9% |
| 9.1% |
We did not purchase or exit any positions during the quarter.
There were no material contributors to performance and no material detractors.
Focus Plus Review
| INVESTMENT STRATEGY (As of 09/30/2023) |
| QTD |
| YTD |
| 1 YEAR |
| 3 YEAR |
| 5 YEAR |
| 10 YEAR |
| Since Inception (03/31/2007) |
| VVP Focus Plus (Gross) |
| -1.9 % |
| 31.5 % |
| 41.8 % |
| 11.1 % |
| 15.7 % |
| 14.3 % |
| 12.4% |
| VVP Focus Plus (Net) |
| -2.0 % |
| 30.6 % |
| 40.7 % |
| 10.1 % |
| 14.6 % |
| 13.4 % |
| 11.3% |
| Russell 1000 Value Index |
| -3.2 % |
| 1.8% |
| 14.4% |
| 11.1% |
| 6.2% |
| 8.4% |
| 6.3% |
| S&P 500 Index |
| -3.3 % |
| 13.1% |
| 21.6% |
| 10.2% |
| 9.9% |
| 11.9% |
| 9.1% |
We did not write any options contracts during the quarter. We use options to lower risk. Equity-like returns are possible when option prices reflect higher levels of implied volatility. If exercised, these options give us the right to purchase stakes in companies we want to own at a lower price than the market price at the time the option was written. We would like for these options to be exercised and have set aside cash for that purpose. We employ no leverage. In effect, we are being paid while we wait for lower prices and a corresponding larger margin of safety. We also use options to exit positions. Generally, we write covered calls with the strike price being our estimate of fair value. As with our puts, we are being paid to do something we would do anyway at a given price.
We did not purchase or exit any positions during the quarter.
There were no material contributors to performance and no material detractors.
All Cap Review
| INVESTMENT STRATEGY (As of 09/30/2023) |
| QTD |
| YTD |
| 1 YEAR |
| 3 YEAR |
| 5 YEAR |
| 10 YEAR |
| Since Inception ( 03/31/2007 ) |
| VVP All Cap (Gross) |
| -4.8 % |
| 18.3 % |
| 27.1 % |
| 2.7% |
| 3.0 % |
| 7.5 % |
| 9.6% |
| VVP All Cap (Net) |
| -4.9 % |
| 17.7 % |
| 26.2 % |
| 1.9 % |
| 2.2 % |
| 6.6 % |
| 8.6% |
| Russell 3000 Value Index |
| -3.2 % |
| 1.7% |
| 14.1% |
| 11.2% |
| 6.0% |
| 8.3% |
| 9.0% |
| Russell 3000 Index |
| -3.3 % |
| 12.4% |
| 20.5% |
| 9.4% |
| 9.1% |
| 11.3% |
| 11.5% |
We purchased one new position during the quarter: Sealed Air Corp. We exited one position during the quarter: Applied Materials Inc. ( AMAT )
There were no material contributors to performance and no material detractors.
Sealed Air ( SEE ) is a global protective packaging company operating in the food and beverage, industrial, and e-commerce markets. The company sells both packaging equipment and consumable packaging. Sealed Air has a strong market position with leading technology and brands. In the food and beverage market, the Cryovac brand is the gold standard for packaging and shipping fresh, uncooked proteins. Food safety is critically important, and customers are willing to pay for quality and reliability. Additionally, switching costs are high and customer relationships are typically sticky and long term in nature. Sealed Air’s brands in e-commerce and industrial include Bubble Wrap and Instapax, and the competitive advantages in these markets are largely similar.
We sold Applied Materials during the quarter as a source of capital to allocate to more attractive opportunities.
CLOSING
We are pleased to announce that we recently reopened our Small Cap strategy which we closed in 2013 and All Cap strategy which we closed in 2014. At that time the portfolios were capacity constrained. We have decided to reopen both strategies because the portfolios have capacity and price to value ratios are at historically attractive levels. We will continue to monitor both price to value ratios and portfolio capacity and will take appropriate action, including closing the strategies again, if conditions warrant.
We appreciate the opportunity to work with you, our client partners. We continue to follow our discipline and lay the building blocks for future compounding. We look forward to updating you again in the new year.
The Vulcan Value Partners Investment Team,
C.T. Fitzpatrick, CFA | McGavock Dunbar, CFA | F. Hampton McFadden, Jr., CFA | Stephen W. Simmons, CFA | Colin Casey
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
For further details see:
Vulcan Value Partners Q3 2023 Letter