2nd Quarter 2010 Commentary
The Fund underperformed its Russell Midcap 400 index benchmark during the quarter, and continues to trail it for the year-to-date through June 30, 2010. The biggest detractors from performance during the period were Unisys Corporation, CGG-Veritas, and The New York Times Company. Unisys, a technology company specializing in outsourcing and information security, declined after reporting a first-quarter net loss primarily due to foreign currency losses. We think the stock was punished unduly given significantly improved operating margins as the company reduced costs and divested non-core assets. The company reported double-digit order growth with new orders mentioned from Microsoft, Unilever, Henkel, and Siemens. We think Unisys remains significantly undervalued at current levels and is positioned to benefit from a growing focus on "cloud computing" (outsourced, network-based IT solutions) and related data security issues.
Energy holding CGGVeritas, a provider of seismic mapping technology and services for oil and gas exploration, was down in conjunction with the Gulf of Mexico oil spill—this after the stock's big gain last quarter on favorable revisions to earnings guidance. We expect the firm's technology to return to favor once the drilling moratoriums expire. New York Times was down in part due to continued weakness in advertising revenues, mainly in real estate and help wanted ads, and selling pressure from a large investor. We continue to believe that the stock remains undervalued given the company's superior brand as a worldwide content provider. Moreover, we see additional revenues from monetizing electronic distribution of content and digital advertising, the latter of which now accounts for 26% of advertising revenues.
Akamai Technologies, Lincare Holdings, and Mentor Graphics were the leading contributors to returns for the Fund during the quarter. Top-holding, and top-performer, Akamai delivered a stronger than expected earnings report in April. The company provides state-of-the-art website optimization and revenues are typically enhanced by surges in Internet use such as during events such as the World Cup. Lincare surged in June after the company announced a 3:2 stock split and annual dividend, the first in the company's history. We took the opportunity to reduce the portfolio's position significantly on the news, and the stock has since pulled back after Medicare competitive bidding announcements revealed larger than expected price cuts. Technology firm Mentor Graphics is benefitting from improving fundamentals as well as activist shareholder Carl Icahn's recent accumulation of Mentor stock. His holdings now stand at 9.5% of the firm.
We took advantage of short-term stock price fluctuations to add to a number of positions and initiate holdings in the Fund in Nuance Communications and Forest Labs based on valuation.
Nuance Communications is a leading provider of speech recognition and PDF imaging technologies. The company's automated speech solutions are sold to the healthcare, travel, automotive (navigation systems), and telecommunication industries, and includes dictation-to-text capabilities for the iPhone and BlackBerry. Within the healthcare segment, Nuance's eScription and Dictaphone Speech Systems replace manual transcription and effectively increase productivity, while decreasing errors and healthcare costs. The firm's recent partnership with IBM will incorporate IBM technology into Nuance's speech solutions with the goal of offering innovative solutions for a broad range of devices. Earnings and revenues have doubled in the past three years and the company appears well-positioned to continue its growth to meet the demand for voice technology solutions. We think the stock appears attractively valued based on a current price/earnings multiple of 13.
Forest Laboratories is a U.S.-based pharmaceutical company specializing in acquiring, licensing, developing, and marketing products across a wide range of therapeutic areas, covering central nervous system, cardiovascular, gastrointestinal, anti-infective, respiratory, rheumatology and endocrinology. Upcoming patent cliffs and the subsequent loss of exclusivity for Forest's two main products, Lexapro in 2012 and Namenda in 2015, have caused the stock to fall from favor. There has been a strong history of successful execution at the firm the past several years. Forest has been building an extensive late-stage pipeline of products to mitigate the expected loss of revenue with Lexapro's patent expiration. We believe that with continued investment in research and development the company should be able to launch multiple products over the next couple of years to keep the product pipeline robust. We view Forest Labs as very attractively valued trading at eight times 2011 earnings, no debt on the balance sheet, and strong cash flow.
Finally, the Fund's position in Edwards Lifesciences was reluctantly eliminated based on valuation after an approximately 10-year holding period during which time the stock appreciated more than 440% versus a benchmark gain of 58% and a 25% loss for the S&P 500 Index.
Second quarter earnings reports are expected to provide evidence that the U.S. economic recovery continues, supported by domestic stimulus and growth in China. While we anticipate the ongoing recovery to continue for the remainder of the year, the rate of growth could dampen as a result of reduced stimulus spending and slow-to-recover employment.
Regardless of the pace of recovery, many of the companies in the portfolio have emerged from the recent downturn with stronger balance sheets and streamlined cost structures, which we believe will improve their staying power and ongoing profitability.
Most importantly, we view the portfolio as very attractively valued. Not only is the Fund's current average price/earnings multiple below that of the benchmark, the price/earnings-to- growth rate has rarely been more attractive than the current 1.1 ratio during the past 10 years. As always, we continue to invest in focused businesses with attractive valuations, strong balance sheets, and proven management teams. We thank you for your continued support and confidence in our portfolio management abilities.
Thyra E. Zerhusen, Managing Director and Portfolio Manager
Marie L. Lorden, Co-Portfolio Manager
Mary L. Pierson, Co-Portfolio Manager
As of June 30, 2010, Unisys comprised 1.71% of the portfolio's assets, CGG Veritas – 1.50%, New York Times Company – 3.23%, Akamai Technologies – 4.65%, Lincare Holdings – 1.37%, Mentor Graphics – 0.72%, Nuance Communications – 2.04%, and Forest Laboratories – 2.64%.
Note: Mid-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.
Past performance does not guarantee future results. Investment return and principal value of mutual funds will vary with market conditions, so that shares, when redeemed, may be worth more or less than their original cost.
Before investing, carefully consider the fund’s investment objectives, risks, charges and expenses. Contact 800 992-8151 for a prospectus containing this and other information. Read it carefully. Aston Funds are distributed by BNY Mellon Distributors Inc.