Following the most recent annual rebalance of the Hennessy Cornerstone Mid Cap 30 Fund, portfolio manager Ryan Kelley uncovered a couple compelling investment themes.
Kelley discussed these themes during the Hennessy Fund’s annual outlook meeting. Kelley has been a portfolio manager on this fund for over a year, joining Neil Hennessy who’s been managing the fund since inception.
The Hennessy Cornerstone Mid Cap 30 Fund (HFMDX for the investor class; HMDX for the institutional class) is a concentrated portfolio of purely mid-cap stocks. The fund focuses on undervalued companies that have proven sales and earnings growth.
The fund utilizes a quantitative formula to select a concentrated portfolio of 30 domestic, mid-cap stocks with the highest 12-month price appreciation. These stocks must also have a market capitalization between $1 and $10 billion; a price to sales ratio below 1.5; annual earnings higher than the previous year; and positive stock price appreciation, or relative strength, over three- and six-month periods.
There are two compelling investment themes in particular that Kelley said the fund is looking at going into 2019. “Within those themes we’re finding forgotten brands and turnaround stories to reinvest in,” he added.
First Theme: Consumer Spending
Consumer spending has been increasing “very nicely,” Kelley said.
According to Kelley, consumer spending has increased eight consecutive months, month-over-month.
“There was one blip in March and then prior to that consumer spending was increasing nicely as well,” he added.
Kelley partly attributes the increased consumer spending to faster wage growth, a “very robust” job growth market, and good consumer confidence.
“They all work together but essentially if you have people with jobs, people making more money and good consumer confidence – you see increased spending,” Kelley said.
Kelley gave two different examples of companies that are benefitting from this theme of increased consumer spending.
“They’re both traditional retail type companies. They’re both companies in transition, and they both have done very well this year but for two very different reasons,” he said.
The first company Kelley gave as an example is the shoe manufacturing company Crocs (CROX). According to Kelley, Crocs has been closing down some of their stores and right-sizing their business.
“They’ve been getting rid of the brick-and-mortar, they’ve been reducing their expenses, and it’s been really helping,” he explained. “They’re showing strong organic growth, and they’re doing all this through their online sales.”
The other company Kelley gave as an example was Restoration Hardware (RH), which is a home furnishings company.
“Another turnaround retail story but for a very different reason. They’re reinvesting in bricks-and-mortar. They’re building out these design galleries,” Kelley said.
According to Kelley, Restoration Hardware is enhancing the customer experience – with, for example, coffee shops within the design gallery – to attract customers into its stores.
“With this type of retail – furniture – you want to see it, touch it, feel it, sit on it, in order to buy it,” Kelley said.
Second Theme: Economic Growth and Capital Expenditure
The second major theme Kelley pointed out is the increased economic growth and capital expenditure.
“Certainly corporations are spending more this year than they were last year,” Kelley said. “We saw 10% increase in year-over-year capital expenditures in the first half of 2018.”
According to Kelley, this driven by increased corporate profits helped primarily by lower taxes, as well as a robust economic environment.
Kelley then also gave an example of a company they’ve added to the Cornerstone Mid Cap 30 Fund that has benefitted from increased capital expenditures.
That company is the trucking company Landstar System (LSTR). According to Kelley, Landstar has a slightly different model than the rest of its industry.
“They have a very asset-like model, which means they don’t have fleets and fleets and fleets of trucks that some might sit idle and sometimes not,” Kelley explained. “That’s a very asset-like model, [which] means their balance sheet is not laden down by a bunch of debt.”
Kelley added that Landstar is showing record earnings growth and record sales growth, as well as benefitting from a “very strong” pricing environment.
“Right now trucking and truck drivers are very high in demand. We think that should continue to be the case for this company and should continue to do well,” Kelley said.
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