1st Quarter 2012
Global equity markets continued to rebound from last year’s third quarter lows driven by stronger U.S. economic data and a break from bad news out of Europe. The Fund slightly lagged its S&P MidCap 400 Index benchmark in gaining more than 13% during the quarter. Overall, the contribution from holdings to absolute returns was broad-based as 15 stocks gained more than 20%. Only three stocks posted losses during the period.
Three technology firms were among the top-five contributors to performance during the quarter, including Itron and CA. Itron provides smart metering solutions to utility companies to collect data for billing systems, analyze usage, and perform remote connect/disconnects. The company reported fourth quarter revenue and earnings results that were much better than consensus estimates. Although growth in North America has slowed, we think the company is positioned to benefit from strength in the Asia-Pacific region and to a lesser extent in Europe and Latin America. IT management software firm CA delivered better than expected revenue and earnings per share, and announced a capital allocation plan consisting of dividend payments (3.6% yield) and a share repurchase program.
Another notable performer was medical development company Charles River Labs. The firm assists pharmaceutical, biotech, and research labs in drug discovery and the testing of their products. During the quarter, the company announced it was engaged in a strategic review of its business strategy, leading to market speculation of a possible split of its two main business units, which could unlock value.
The three stocks that declined during the quarter were The New York Times Company, FMC Technologies, and Southwest Airlines. In addition, Pearson and Lincare Holdings posted only meager gains in underperforming the benchmark.
The New York Times Company’s stock decline owes primarily to the lack of any relevant news and the ongoing search for a new CEO. The company successfully launched a paid digital subscription service a year ago and just reported more than 450,000 digital subscribers. Print subscribers are up as well as home deliveries grew during the fourth quarter of 2011. In our view, the stock appears substantially undervalued.
Deep-sea oil production equipment provider FMC Technologies reported lower than expected earnings citing higher project costs and expenses. These execution issues are in part a function of higher volumes and the challenges associated with managing growth—including adding employees. Revenues met expectations and the book-to-bill ratio rose from the prior quarter. The stock decline followed a 39% gain during the fourth quarter of 2011.
Despite higher fares and significantly reduced capacity, high fuel costs due to current oil prices weighed on airline profitability, including that of Southwest Airlines. Southwest is the sixth largest US airline and ranks first in the number of originating passengers boarded. The company has one of the best overall customer service records in the industry, operating a low-cost, point-to-point model without added fees. We expect the company to see increased revenue from improved business travel and a better domestic footprint after it integrates AirTran (an acquisition completed May 2011).
Positioning and Outlook
The Fund sold two positions during the first quarter—Pearson and PerkinElmer. Pearson delivered substantial gains during the portfolio’s holding period from August 2003 through March 2012, more than doubling that of the broad market S&P 500 Index. The stock reached our valuation target and was near the top end of our mid-cap market capitalization range of $15 billion. PerkinElmer doubled from April 2009 through February 2012, again significantly outperforming the S&P 500. The company’s acquisition strategy made the company less focused on its primary business than we prefer. Elsewhere, we took advantage of short-term price fluctuations to rebalance the portfolio, trim stocks with higher valuations, and add to more attractively valued stocks.
As the market continued to rise during the first quarter, the macro environment remains mixed. The most recent Federal Reserve minutes suggest a reduced chance of further monetary stimulus. This reflects a more positive opinion of the underlying economy. The U.S. presidential election adds an element of uncertainty. News out of Europe remains mixed, with the European debt crisis far from over in spite of larger safety nets and promises of sovereign debt reform. With all of the focus on broader trends, the coming earnings season could offer some surprising stock moves based on unexpected company specific news. Alcoa provided the first significant example. The aluminum producer (aircraft, cars, beverage cans) surprised Wall Street by announcing a much better than expected quarter. Alcoa mentioned that most industrial sectors looked strong in North America.
We remain positive on the outlook for North America. The economic recovery is continuing. Despite strong equity returns in the preceding two quarters, valuations continue to remain attractive. By our calculation, the portfolio trades at less than 13 times 2012 earnings, below that of the Fund’s benchmark and the S&P 500. Corporate balance sheets remain strong generally, with many companies continuing to return cash to shareholders through increased dividends and stock repurchase activity.
Thyra E. Zerhusen, Chief Investment Officer
Marie L. Lorden, Portfolio Manager
Mary L. Pierson, Portfolio Manager
As of March 31, 2012, Itron comprised 3.19% of the portfolio’s assets, CA – 1.83%, Charles River Laboratories – 2.41%, The New York Times Company – 2.83%, FMC Technologies – 2.55%, Southwest Airlines – 2.50%, Pearson – 0.00%, Lincare Holdings – 1.52%, and Alcoa – 0.00%.
Note: Mid-cap stocks are considered riskier than large-cap stocks due to greater potential volatility and less liquidity.
Before investing, consider the Fund’s investment objectives, risks, charges, and expenses. Contact 800 992-8151 for a prospectus or summary prospectus containing this and other information. Please, read it carefully. Aston Funds are distributed by Foreside Funds Distributors LLC.