1st Quarter 2012
Forget About Spring, It Feels Like Summer
Stocks sizzled in the first three months of 2012, delivering the best first quarter return since 1998 (as represented by the broad market S&P 500 Index). Forgive us if we suggest that perhaps we have seen this movie before—a strong first quarter in the markets followed by a sharp correction as fundamentals weaken. Is it different this time? We are optimistic the economic expansion will follow through. We see consumers slowly waking up from their four-year slumber. Looking at retail sales growth, consumer spending has improved, while U.S. unemployment has receded to 8.2% as of March 2012. Consumer sentiment data corroborates this trend with its highest reading since the recovery began in 2009. Furthermore, the Federal Reserve’s recent bank stress test reflects improved capital ratios and the ability of major financial institutions to withstand a severe downdraft in the economy. This places U.S. banks in the lead relative to their European counterparts. In addition, the Federal Reserve and most central banks globally are providing ample liquidity to help boost economic growth. Although volatility will likely remain a factor this year, corrections should provide us opportunities to add to portfolio positions. We believe signs point to the U.S. leading global economies toward expansion.
The Fund outperformed its Russell 2000 Index benchmark during the quarter as stocks continued to move higher and added to the advance from the fourth quarter of last year. Strong stock selection overcame underweight positions in the two top-performing sectors of the benchmark. Overall, sector allocation was slightly positive as zero exposure to Utilities aided returns as that sector was one of the few areas of the market to lose ground. Financials and Industrials were strong contributors on an absolute basis, while holdings in Materials and Financials were the biggest contributors relative to the index.
Westlake Chemical, Athenahealth, and Coinstar were the three biggest individual contributors to performance during the period. Westlake, within the Materials sector, was the beneficiary of low natural gas prices, the basis for its low feedstock prices relative to oil-based feedstock, as well as its offer to acquire rival Georgia Gulf. Healthcare practice management and billing IT firm Athenahealth rebounded from its December correction after reporting strong top- and bottom-line growth relative to its guidance. We continue to think the company’s highly ranked software-as-a-service model is well suited for the small physician space, and that it can continue to gain market traction. Coinstar was the beneficiary of a new business alliance with Verizon, an increase in market share, and good earnings relative to guidance.
Positions in Consumer Staples and Energy detracted the most from relative performance, as did residual cash held amid the strong rally. Private label food distributor Treehouse Foods within Consumer Staples underperformed after a revenue and earnings miss during the quarter due to higher costs and a mix shift toward lower margin goods. In Energy, natural gas producer Bill Barrett suffered from the effect of weak natural gas commodity prices on earnings. The stock was sold during the quarter as a source of capital for more attractive relative opportunities.
As we like to reiterate, the portfolio is broadly diversified with sector allocations resulting from opportunities we identify at the stock level through our bottom-up, fundamental analysis and valuation work. The most notable shifts during the quarter were a decline in the weightings of the Technology and Industrials sectors due to profit taking and an increase in Consumer Discretionary as valuation and fundamental improvements led to new purchases. The three largest sectors in the Fund as a percentage of assets at the end of March were Consumer Discretionary, Financials, and Industrials. We view Financials as still providing opportunities to invest in leading companies at attractive valuations. As consumer spending continues to improve, we think there is an opportunity for significant margin expansion among Consumer Discretionary companies where many could reap the benefits of multi-year cost reduction efforts.
Three stocks were purchased during the quarter and reached full-position status—Chico’s FAS, MDC Holdings, and Waddell & Reed Financial. Following years of robust growth and market share gains, woman’s apparel retailer Chico’s fell out of favor with investors given overexpansion, heightened competition and weaker merchandising, which led to years of free cash-flow and return on invested capital deterioration that was compounded by the economic recession. A new management team was put in place three years ago to direct a multi-year restructuring in response to an activist shareholder. In our view, the stock represents an attractive, late-stage restructuring opportunity with an attractive valuation combined with evidence of a successful turnaround that offers additional long-term opportunity.
Homebuilder MDC has responded to the depressed industry conditions of the last few years by dramatically reducing operating costs and maintaining a very liquid balance sheet. As the housing market firms, we believe profitability at MDC can improve dramatically as its strong financial position allows it to opportunistically invest for growth. Asset manager Waddell & Reed manages approximately $80 billion in a variety of asset classes for individual and institutional investors. Led by a tenured management team, the company has historically produced strong relative investment performance. Management has also returned capital to shareholders via a consistently increased dividend and share buybacks, and we believe the stock is supported by a compelling valuation and yield.
Five full positions were sold from the portfolio in addition to the previously mentioned Bill Barrett during the quarter. Aaron’s and Colonial Properties were sold primarily due to valuation, while asset manager GAMCO Investors was used as a source of capital to fund more attractive relative opportunities. Software companies RightNow Technologies and SuccessFactors both received buyout offers and were trading very close to their buyout prices. RightNow was purchased by Oracle for $43 per share and SuccessFactors was bought by SAP for $40 per share.
TAMRO Capital Partners
As of March 31, 2012, Westlake Chemical comprised 2.55% of the portfolio's assets, Athenahealth – 2.62%, Coinstar – 2.76%, Treehouse Foods – 1.95%, Bill Barret – 0.00%, Chico’s FAS – 1.85%, MDC Holdings – 1.64%, and Waddell & Reed Financial – 2.52%.
Note: Small-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.