4th Quarter 2011
Great Quarter, Tough Year
The Fund rebounded strongly during the fourth quarter in posting double-digit gains and outperforming its S&P MidCap 400 Index benchmark by more than four percentage points. The end-of-year surge somewhat eased a tough 2011 overall that saw the Fund underperform the benchmark by a wide margin.
The fourth quarter outperformance was encouraging: 18 stocks rose more than 20% and only four stocks declined. Top contributors included Akamai Technologies, Gannett, and H&R Block. Long-time holding Akamai reported strong third quarter revenue growth and announced plans to acquire Cotendo, a competitor. We think the acquisition should have a positive impact on the firm’s margins. Broadcasting and publishing company Gannett (USA Today, television stations, regional newspapers, CareerBuilder) continues to generate strong cash flow and has a solid balance sheet, while we think its stock remains attractively valued with a low price/earnings multiple and a healthy dividend yield. H&R Block has refocused on its core business (assisted tax preparation) and divested itself of its non-core mortgage and broker/dealer businesses. The firm has been able to return cash to shareholders through share repurchases and a sizeable dividend.
The worst performers for the quarter were three Healthcare stocks—Boston Scientific, Charles River Laboratories, and Forest Laboratories—all of which were in negative territory. Medical device company Boston Scientific declined after the company reported continued pricing pressure in its stent business. The firm is in the midst of a multi-year transition, with its stock remaining attractively valued with a current price/sales ratio well below its five-year historical average. Charles River is a provider of products and services that assist pharmaceutical and biotech companies in accelerating research and drug development. With market conditions for big pharmaceutical companies stabilizing, outsourcing to firms like Charles River is expected to pick up. We are encouraged by the company’s focus on key initiatives, which include controlling operating costs, improving free cash flow, and returning cash to shareholders. In our view, the stock appears substantially undervalued at current levels. Forest Labs, a U.S.-based pharmaceutical company, continues to build out a significant product portfolio. Nine new drugs are in the pipeline to replace products coming off patent in 2012 and 2015. The company has implemented an accelerated share repurchase plan, and remains focused on restructuring efforts. With the stock trading at only seven times estimated 2012 earnings, we think the risk/reward potential is compelling.
Buys and Sells
The Fund eliminated its remaining positions in FactSet Research Systems and URS Corp. during the quarter. FactSet had nearly doubled from its purchase in March 2008 to when we sold it in December, while the broader market (as defined by the S&P 500 Index) declined 3%. FactSet reached our valuation target and we think that its user base may decline with financial industry layoffs. Engineering firm URS declined during the portfolio’s holding period from April 2008 through November 2011, though less so than the overall market. We made the decision to exit URS due to the lack of federal and municipal funds available for infrastructure related projects.
At the end of October, the Fund initiated a position in global specialty pharmaceutical and medication delivery company Hospira, which had spun off from Abbott Laboratories in 2004. Just prior to the purchase, the firm had highlighted manufacturing issues at two of its facilities that depressed the stock and provided an attractive entry point. We expect the manufacturing issues to be resolved in the intermediate-term and believe the news is well discounted in the stock price. The valuation appears compelling with the stock trading at the low end of the company’s five-year range, at levels similar to 2004.
Outlook and Perspective
The domestic economy has shown some encouraging signs recently. Employment numbers have improved, while U.S. auto sales grew 10% in 2011. For the first time in two decades GM, Ford, and Chrysler all reported increased market share in the same year. In January, long-term holding BorgWarner, a leading producer of highly engineered automotive products with a focus on improved engine performance and fuel efficiency, increased its 2012 guidance.
At the end of the third quarter, we commented on the historically cheap valuation of the portfolio. Even with the gains made during the fourth quarter, we think it continues to be attractively valued compared with the major mid-cap benchmarks and the S&P 500. The average price/earnings ratio of the portfolio is less than that of the benchmark and its overall price/earnings to growth (PEG) ratio is at the low end of its historical range. In addition, we think the portfolio holds companies with better balance sheets than the broader market, with a lower long-term debt-to-capital ratio than that of the S&P MidCap 400 and Russell MidCap Indexes. Given the stabilizing and improving U.S. economic environment and current fundamental characteristics in absolute and relative terms, we believe the portfolio is well-positioned.
Thyra E. Zerhusen, Chief Investment Officer
Marie L. Lorden, Portfolio Manager
Mary L. Pierson, Portfolio Manager
As of December 31, 2011, Akamai Technologies comprised 4.25% of the portfolio’s assets, Gannett – 3.42%, H&R Block – 4.71%, Boston Scientific – 3.91%, Charles River Laboratories – 2.15%, Forest Laboratories – 2.70%, Hospira – 2.25%, and BorgWarner – 2.13%.
Note: Mid-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.
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.