Outlook:
The United States economy is on solid footing, though growing at a modestly slower pace than over the past few years. We think a 2.0% rate of growth is consistent with the recent slowing business investment activity caused in large part by uncertainties related to trade negotiations. We expect those negotiations to be practically resolved in early to mid-2020 as the US election cycle approaches. Below is a graph of the past four years of US economic growth as measured by Gross Domestic Product (GDP):
US Personal Income is another indicator of the wellness of the economy as measured through individual earnings. Personal income has consistently increased since the end of the 2008-2009 downturn. In addition, as noted below in the row entitled Personal Savings, Americans are saving roughly 8% of compensation – consistent with the current near full rate of employment.
The rate of US unemployment is at a 50-year low, with just 3.5% of the labor force unemployed. It is no surprise the consumer has been a large contributor to economic growth.
Inflation at both the producer and consumer level remains in check with annual rates hovering consistently around a 2% level.
In a recent speech at the annual meeting of the National Association for Business Economics, Ms. Esther George, President of the Federal Reserve Bank of Kansas City, stated, “the US economy is currently in a good place with low inflation, low unemployment, and an outlook for continued moderate growth.”
An accommodative Fed has been a primary driver of market gains this year. The central bank lowered rates in July for the first time since the financial crisis and followed up with another cut in September.
We believe there will be continued political and economic unrest around the globe as most major central banks provide ongoing policy accommodation in the form of lower interest rates, the UK and European Union work through details of a potential Brexit agreement, social unrest and demonstrations continue in Hong Kong, tensions increase across the Middle East with repeated hostilities and the threat of oil supply disruptions, and political jockeying accelerates in Washington, DC. Situations like these invariably create uncertainty and investment price variability.
Portfolio:
The accelerated level of economic and political uncertainty has created a more attractive investment environment. Over the past few weeks the Dow Jones Industrial Index has had numerous days in which it swung from negative to positive and back again, moving several hundred points or more. We appreciate price variability and the irrational behavior it begets as this leads to the short-term mispricing of stocks and bonds. We remain confident in the securities we hold, our investment strategy, and our rigorous analytical process. Although the prices of many of the companies we hold remain depressed, we see through the short-term price volatility to discern the long-term value of the underlying businesses. This is where our analytical process focus is – not the last quoted stock price.
Equity:
AutoWeb, Inc. (AUTO)
A US-based automotive marketing services company providing high-quality consumer leads, internet advertising, and associated marketing services to automotive dealers and manufacturers throughout the United States. The company’s products include new and used vehicle lead generation programs, which allow consumers to submit requests for pricing and availability of specific vehicle makes and models within a geographic area, and online advertising programs including impression-based and click-through ads. Management has developed and is executing a strategic plan that we expect will lead to meaningful value creation. A normalization of revenues and margins should cause AUTO to trade in line with historic multiples. A highly experienced executive management team has been installed over the past eighteen months creating opportunity for AUTO to expand well beyond its prior base business. The share price remains well below our appraised value.
Core Molding Technologies, Inc. (CMT)
A US-based manufacturer of sheet molding compound and various fiberglass- and plastic-based heat-molded products. The company’s customers include makers of heavy-duty trucks, automobiles, personal recreational vehicles, and a variety of consumer and industrial goods that incorporate high-strength molded components. CMT recently acquired Horizon Plastics, a Canadian manufacturer of high-strength structural plastic components; the combined company presents attractive synergistic opportunities. A recently installed CEO is leading an operational turnaround that focuses heavily on manufacturing efficiencies; early results are evident. The company has operations throughout North America. The share price remains well below our appraised value.
Corning Incorporated (GLW)
A US-based global manufacturing business that produces display glass, fiber optic cables, emission control products, medical and pharmaceutical equipment, and specialty glass. Widely-known products include Gorilla Glass, a durable display glass used in mobile electronic devices, and Valor Glass pharmaceutical vials, in which the company is investing heavily. GLW is among the foremost providers of fiber optic cables, which will play an increasingly important role in continuing development of global telecommunication infrastructure. GLW’s business has improved over the past few years, narrowing its market value compared to our appraised value, but growth opportunities remain as 5G fiber connectivity and improvements in light weight glass allow for greater uses
Flexsteel Industries, Inc. (FLXS)
A US-based manufacturer of wooden, metal, and upholstered furniture. Short-term trade concerns and disruptions stemming from the partial implementation of a new business information system have caused consternation among market participants. Longer-term, we expect FLXS to recover lost revenue, implement control costs, rationalize its operating footprint, and return to its previous margin profile while growing the business both organically and through small acquisitions. The company has a strong cash position and no debt. New CEO Jerry Dittmer brings significant industry experience and managerial knowledge. FLXS will continue to play a role in fulfilling the need for furniture across a range of price points while adapting to changing customer preferences. The share price remains well below our appraised value with a cash-rich balance sheet and no debt.
Fluent, Inc. (FLNT)
A US-based digital marketing business offering performance-based marketing solutions through targeted digital interactions. FLNT is growing rapidly, and we anticipate that investors will soon appreciate the business’s healthy margins and cash generation potential, resulting in significant price appreciation. Excesses cash from operations may be used to prepay debt or for accretive acquisitions. The company possesses a desirable competitive position, unique products, and a young and innovative workforce. We maintain a high degree of confidence in Fluent’s management team. The share price remains well below our appraised value
Gulf Island Fabrication, Inc. (GIFI)
A US-based fabricator of complex offshore steel structures for customers in the oil and gas and other marine industries. GIFI also fabricates marine vessels, including tugboats, offshore supply vessels, civilian transportation vessels, and government vessels. The company is well-positioned to participate in a developing US offshore wind energy market and a renaissance in petrochemical processing on the US Gulf coast. GIFI has a strong liquidity position after rightsizing its physical footprint. We expect continued improvement in backlog and general business conditions. The company has balance sheet cash nearly equal to the current share price with zero debt and an additional seven dollar per share of assets. The shares trade well below our appraised value.
Kraft Heinz Company (KHC)
A US-based diversified manufacturer and marketer of food and beverages products. In 2015, Warren Buffett’s Berkshire Hathaway and investment firm 3G Capital orchestrated the merger of Kraft Foods and H.J. Heinz; the two firms hold a combined equity position in KHC of nearly 50%. Aggressive cost cutting after the merger led to an underinvestment in legacy brands, resulting in an impairment of goodwill in early 2019. Market sentiment is decidedly negative, but we believe KHC’s business is fundamentally sound. At current prices, the dividend yield is approximately 5%. We expect new CEO Miguel Patricio to be a catalyst to value creation. The share price remains well below our appraised value.
LSB Industries, Inc. (LXU)
A US-based producer of nitrogen-based agriculture and industrial products at three domestic facilities and one non-owned staffed plant. Ongoing changes to operational and maintenance procedures will improve onstream rates. Margins on industrial products are attractive and relatively stable. A cyclical upswing in agricultural fertilizer pricing is underway, which should lead to improved margins in the agriculture segment. A recent debt refinance has provided additional operating flexibility, and we expect further balance sheet strengthening as cash flow improves. LXU has demonstrated excellent execution under new management. The share price remains well below our appraised value.
New York Community Bank, Inc. (NYCB)
A US-based mid-tier consumer and commercial bank offering deposit and loan products and services. NYCB has established a niche lending position in rent-controlled residential multi-family housing buildings in New York City and has recently shown growth in its specialty commercial financing business. Loan loss provisions and actual write-offs are substantially and consistently among the lowest in its peer group. Recently legislation raised the threshold that defines a Systematically Important Financial Institution (SIFI) from $50 billion to $250 billion. NYCB has begun growing after several stagnant years and we remain optimistic about the potential for it to acquire another bank or be acquired. The share price remains well below our appraised value.
Seaspan Corporation (SSW)
A Hong Kong-based, globally-operated independent owner and manager of oceangoing container ships which are chartered on long-term, fixed-rate time charters to various established container liner companies. Market recovery from a period of depressed charter rates due to an oversupply of vessels is underway. We believe industry and economic conditions remain favorable in the medium- to long-term. As new management continues to reshape the balance sheet, we anticipate strategic acquisitions. The share price remains below our appraised value.
StealthGas Inc. (GASS)
An Athens, Greece-based, globally-operated shipping company that provides seaborne transportation of liquified petroleum gas (LPG). GASS is dominant in the small-sized pressurized gas shipping market. The LPG shipping market continues to improve with accelerating demand for product transportation and a favorable outlook for global fleet growth in the segment. We believe GASS is trading at an attractive discount to net asset value and has significant appreciation potential. The share price remains well below our appraised value.
Subsea 7 S.A. (SUBCY)
A London, England-based, globally-operated company providing seabed-to-surface engineering, construction, and services to the offshore energy industry. SUBCY’s stock was disproportionately discounted during a period of reduced offshore oil and gas exploration and production activity but has benefitted from improving markets and normalizing capital expenditures by its customers. The acquisition of Seaway Heavy Lifting has provided exposure to the growing offshore renewable energy market. SUBCY’s technology portfolio is among the best in its industry. The share price remains below our appraised value.
TravelCenters of America, Inc. (TA)
A US-based business operating and franchising North American highway system travel centers with fuel and convenience store services for business and casual travelers. Expansion of the core travel centers business coupled with improvements in servicing capabilities position the company for revenue growth and margin improvement. The company’s portfolio of unique assets has substantial intrinsic value. The share price remains well below our appraised value.
UFP Technologies, Inc. (UFPT)
A US-based designer, engineer, and producer of high-grade foam and molded fiber solutions for electronic, medical, and specialty packaged products. UFPT recently completed a reorganization of its production assets to more efficiently serve its growing customer base in a highly- fragmented industry. Management has executed on its plant consolidation and rationalization plan, and in the process continued to drive shareholder value. The recent acquisition of Dielectrics increases exposure to lucrative medical markets. We believe there is additional share price appreciation potential.
Wayside Technology Group, Inc. (WSTG)
A US-based, globally-operated technology wholesale company that resells computer software and hardware developed by others, as well as provides technical and related customer services. Top-line growth has been consistent but net margins have been compressed. We believe recent management changes and an associated revitalization of the sales organization will be accretive to the bottom line. The share price remains well below our appraised value.
Debt:
GE Capital Corporation VRN due 3/15/2023 (36966THT2)
A global technology and financial services company that develops and manufactures products for the generation, transmission, distribution, control and utilization of electricity. Its products and services include aircraft engines, power generation, water processing, security technology, medical imaging, business and consumer financing, media content and industrial products.
The variable rate provides a hedge against rising interest rates while maintaining a short duration.
We expect GE to focus on deleveraging its balance sheet though asset sales and restructuring.
Kraft Heinz Foods 3.00% due 6/1/2026 (50077LAD8)
A US-based, globally diversified manufacturer and marketer of food and beverages products. In 2015 Berkshire Hathaway and investment firm 3G Capital orchestrated the merger of Kraft Foods and H.J. Heinz; the two firms hold a combined equity position in KHC of nearly 50%. Aggressive cost cutting after the merger led to an underinvestment in legacy brands, resulting in an impairment of goodwill in early 2019. Market sentiment is decidedly negative, but we believe KHC’s business is fundamentally sound. We anticipate improved cash generation will allow KHC to refinance its debt while continuing to deleverage.
Owens & Minor, Inc. 4.375% due 12/15/2024 (690732AE2)
A US-based company that engages in provision of services to the manufacturers of healthcare products, supplies, and devices. It operates through the Global Solutions and Global Products segments. The Global Solutions segment includes United States and European distribution, logistics and value-added services business. The Global Products segment manufactures and sources medical surgical products through production and kitting operations. A recent change in executive management and improved operations has produced greater profitability and cash-flow. We expect the company to sell itself or restructure and reduce its overall debt.
Pitney Bowes Inc. 4.95% due 4/1/2023 (724479AN0)
A US-based, globally focused technology company which engages in the provision of products and solutions in the commerce industry. It offers information management, location intelligence, and customer engagement products and solutions and also provides shipping, mailing, fulfillment, returns and cross-border ecommerce products and solutions that enable the sending of parcels and packages across the globe. We believe the company is the subject of a private equity transaction that will privatize the business. At a recent investor conference, company management suggested to us a balance sheet restructure was possible that would lead to an early retirement of this debt.
Trinity Industries, Inc. 4.55% due 10/01/2024 (896522AH2)
A US-based company that engages in the provision of rail transportation products and services in North America. It operates through the following segments: Railcar Leasing and Management Services Group, Rail Products Group and All Other. The company recently split into two businesses as part of its long-term restructuring plan which improved its balance sheet and operations. We expect the price of the bonds to improve along with its strengthen business.
United States TIPS 0.375% due 1/15/2027 (912828V49)
A direct obligation of the government of the United States of America, with the largest economy in the world having annual economic production in excess of $20 trillion. Returns on TIPS are bifurcated into semi- annual interest payments and an appreciation in the corpus that reflects the sum of headline inflation, as measure by the US Consumer Price Index (CPI), over the life of the bond. We anticipate future accelerated inflation and use TIPS as a hedge.
United States TIPS 1.75% due 1/15/2028 (912810PV4)
A direct obligation of the government of the United States of America, with the largest economy in the world having annual economic production in excess of $20 trillion. Returns on TIPS are bifurcated into semi- annual interest payments and an appreciation in the corpus that reflects the sum of headline inflation, as measure by the US Consumer Price Index (CPI), over the life of the bond. We anticipate future accelerated inflation and use TIPS as a hedge.
Cash Equivalents:
We continue to hold above average amount of cash reserves in portfolios. We have done so for the past few years as we’ve patiently waited for better valuations.
To improve returns on cash holdings, we’ve been investing in 90-day Treasury Bills. Every 30 days we roll over a new T-Bill so that over a three-month period we end up holding a 30, 60 and 90-day T-Bill, creating a ladder of liquidity.
T-Bills are direct obligations of the US Government and arguably the safest, most liquid asset in the world. We invest in T-Bills due to their safety and return characteristics – our last three T-Bill investments earned annualized returns of 1.87%, 1.97% and 2.12%. Compared to an average yield of 0.09% on FDIC-insured bank account, we are earning a sizable return on cash.
Strategy:
We seek to invest in stocks when they can be purchased at irrational price levels. This applies to bonds as well. We recently invested in the bonds of Signet Jewelers Limited, purchasing $1,000 bonds at a depressed price of $870. Within weeks of our purchase, the company offered to buy the bonds from current holders for $950. We apply the same principals of mispriced stock analysis to our bond analysis.
To be sure, there are situations in which our analysis falters. For instance, we bought shares of Bristow Group, Inc. in 2018 for $8.00. After a series of poorly executed decisions by the executive team and board of directors, the company sought protection through bankruptcy court. Given these types of exceptional situations, we manage portfolio risk by committing just a small percentage of any portfolio to a single position; that way, if a business fails to meet our expectations, we limit any loss to one that is small and manageable. We never plan to make unprofitable investments, but recognize that factors beyond our control can lead to unplanned outcomes. As such, we manage capital with a defensive bias.
We believe that business managers are important to a successful investment outcome. Consequently, we speak with management before making an investment and frequently throughout the life of our holding. When appropriate, we visit with management in person. Over the past quarter we had onsite meetings with Flexsteel Industries, Inc. (Nasdaq: FLXS) in Dubuque, IA, Gulf Island Fabrication, Inc. (Nasdaq: GIFI) in Houston, TX, and LSB Industries, Inc. (Nasdaq: LXU) in Oklahoma City, OK.
We frequently attend investment conferences where we listen to multiple companies speaking with institutional investors about their businesses, often followed by one-on-one meetings. We review dozens of companies in order to identify a single suitable new investment. Research conferences are a terrific place to gain an initial exposure to a company and its executive management team.
While we can’t visit every company or meet them at conferences, we do speak quarterly with the management teams of nearly every company in which we invest. As companies report earnings and provide financial updates, we supplement our research file with a telephone conversation to discuss details that may not be obvious from published information. It is because of our frequent and in-depth engagement with executive management that we are able to influence company boards and other institutional investors through our operational activist initiatives. As in the case of Wayside Technology Group, Inc. (Nasdaq: WSTG), a company where our CEO sits on the board, we share our strategic perspectives in order to impact financial results for all shareholders.
We are uncovering more interesting investment opportunities now than at any time over the past few years. We are increasingly optimistic given the recent price variability and broad market slump. We are seeing wide discrepancy between prices and valuations, which is very encouraging. Many of the large, popular stocks that have dominated headlines recently are dramatically overvalued. Just as trees don’t grow to the sky, these elevated valuations are bound to fall – this correction process is a positive for markets in general. As new investment opportunities arrive, we will deploy cash reserves in accretive endeavors.
From Our Library:
Nearly every week GVIC associates read a chapter from a selected book with industry relevance. We recently completed Flash Boys by Michael Lewis. The book is a critique of high-frequency trading, the much-maligned investment strategy that presupposes one can gain an edge through very fast and frequent trading in and out of securities.
As a group we were fascinated with the algorithmic trading strategies and Lewis’ captivating writing style, as he described back room deals and ‘dark pools’ where off-exchange trades are becoming more and more common. But this all seemed inconsistent with our day-to-day experiences in the capital marketplace; naturally this led us to pick up a second book on the subject, Flash Boys – Not So Fast by Peter Kovac, an experienced Wall Street trader and compliance officer. Mr. Kovac was quick to shine a light on many of the exaggerations and overstatements purported by Lewis.
Our takeaway: continue with our long-term, fundamental approach to investing and ignore those investors with time horizons often spanning less than a second. Also, a good dose of skepticism with a critical thinking overlay remains useful with our investment strategy.
Firm Update:
After more than twelve years in our current location, we are moving to the city. On December 1st we will move to a new downtown Milwaukee office located at 1433 N. Water St. This move is in response to the changing needs of our dedicated associates as well as evolving workspace requirements. A reminder letter with our new address will be sent in November. Our phone numbers and e-mail addresses will remain the same. We welcome your visit if you should be in the area.
Of greater interest and importance, JP and his wife, Erin, are expecting their first child in late November. Please be sure to congratulate him when you next speak.
We wish to thank Prakash Goath of our India office for his nearly four years of service to the firm. He has decided to relocate to his hometown in northern India to be closer to his family. His positive attitude and insatiable curiosity will be missed.
Concluding Thoughts:
Each day brings new challenges and continued learning for all of our associates. Our internal processes continue to improve as the firm matures and new associates are hired. I am grateful to all of our clients, both new and old, for your trust and confidence.
We remain committed to achieving long-term investment excellence by investing intelligently and opportunistically. Our capital is invested in the same companies we recommend. Please call anytime for a more detailed discussion of our strategy and market outlook. We are always happy to share our views and outlook.
Your Investment Research and Advisory Team
Global Value Investment Corp.