Sat, 5 Jan 2013
As stateside growth remains sluggish, Bill Frels and Mark Henneman--Morningstar's 2012 Domestic-Stock Fund Managers of the Year--note that some of their top long-term holdings are going beyond boundaries.
David Falkof: Let's talk about some of the top performers this year, why the fund did so well. One of the top holdings, Valspar, is a Minnesota-based company and very good long-term performer, and particularly this past year.
Bill Frels: Fortunately, Valspar was one of our larger holdings and then became the largest holding in the fund because of significantly better-than-expected performance. We certainly weren't looking for the performance that Valspar eventually gave us over the course of the year, even though we've owned the company for quite a few years and have had management into our office. We have made visits there on a number of occasions, and we are very familiar with it. But Valspar did some things establishing their Valspar-branded paint and also margin improvements. And I think some of their markets turned out to be a little stronger than many had expected earlier in the year, and despite a pretty lackluster economy, they were able to really show strong relative earnings performance, which gets investors' attention pretty quickly these days.
Mark Henneman: I think that a number of things happened kind of all at once for Valspar. I mean a lot of people are now planning on a recovering housing market, and of course, people need to paint their new homes. And I think they look at Valspar as a way to play that. But back to what Bill said that branded Valspar paint, which you can buy Lowe's, that change happened a little over five years ago, and the company continues to benefit from that because they are achieving better-than-expected margins on what is now their branded paint. We think that Valspar has done an excellent job of building a durable competitive advantage around itself.
Falkof: Another company that did really well this year was Toro, another large holding in the portfolio also based in Minnesota. What attracted you to Toro, and why did it do so well?
Frels: We have been an owner of Toro for many years, but the company embarked on a fairly aggressive longer-term profit-improvement program in the mid to late-1990s. And they would set objectives, then they'd meet those objectives, and they'd reset higher objectives. And it was one of these situations where a company does have cyclicality, some based on weather conditions with snow blowers and moisture conditions. And then there is the cyclicality element too, being a durable-goods producer with high-end mowing equipment for commercial golf course applications. So, everything kind of has come together for the company in recent years. And they benefit from foreign growth markets--China, Japan, and India--hopefully, in the years ahead where golf is becoming more and more popular as the middle class expands.
Henneman: A great story to capital. They've paid a dividend here recently. They don't make big acquisitions. They are investing in microirrigation, which we think could be a very big market for them in the distant future. And so, along with their core business, which has been performing extraordinarily well, there is kind of additional upside with some of the investments they are making today.
Falkof: And then sort of different type of stock for you guys is Schlumberger. Historically, Mairs & Power Growth has not owned energy companies, and then Schlumberger was purchased in the middle of 2012. Can you talk a little bit about sort of why now you are sort of looking at that?
Frels: Well, the reason we haven't owned energy is demand for energy tends to grow with gross domestic product not in excess or at least on a trend-line basis. So, final demand is not what we would characterize as a growth area of the economy. And with commodity prices playing a significant role in the earnings progress of major energy companies, we felt that it really didn't fit what we were trying to accomplish.
Schlumberger, as you know, is a little different animal that is tied to energy and energy pricing, but it's a very technical company that sells its products and services not only to the private companies like ExxonMobil, Chevron, but the national oil companies owned by governments that are involved in exploration programs, as well. And with Schlumberger, many of the products and services necessary for completing gas and oil wells require increasing sophistication in terms of drilling the well and completing it. So, we felt that this would give us some exposure to the obvious growth in energy needs looking ahead.
Falkof: Let's talk about the future for the fund. You mentioned that you are attracted to Toro for its international expansions, and are there other companies that you feel in the portfolio are also doing well at getting access to international markets as opportunities for growth?
Frels: For many years the flagship holding has been 3M, a very large multi-billion-dollar company, which last year had close to 70% of its sales coming from outside of the United States and they have been involved in the international arena for many, many years. And we just feel that 3M will give us significant exposure to growth outside the U.S. and especially in emerging markets, where I think the new management plans on increasing its focus, recognizing the fact that the U.S. is in a slow-growth environment, which is likely to continue for a while.
Henneman: There are couple other names we find interesting now. Long-term holdings are Donaldson, which didn't perform very well last year, a combination of a slowdown in the off-road truck market and probably the fact that was overvalued at the end of 2011. But we think that the off-road truck market is going to recover; we think the company is going to get great exposure to gas turbine builds going forward. They provide the filters for the gas turbines. They got PowerCore technology, which continues to rollout and is a huge advantage relative to the other filtration opportunities out there. And so, things are really lined up nicely, and it's got not a cheap valuation at 16 times earnings, but about as cheap as Donaldson gets. So, we think that's attractive.
And then another one that's getting its international exposure is Target, which has been a completely domestic play, and that's changing now with their move into Canada, which we think is going to be very successful. And Target has been mostly just spending the money that it takes to roll out into Canada. This 2013 they will start getting the benefits of that rollout, and we will see accelerating earnings growth there. And the recent holiday season was a little bit disappointing; the Neiman Marcus joint venture didn't work quite as well as people had thought. And so the valuation has become pretty attractive here. So, that one is another one we find pretty attractive right now.
Falkof: Again congratulations on being named Morningstar's 2012 Domestic-Equity Fund Managers of the Year. Thanks for joining us.
Henneman: Thank you.
Frels: Thank you, David.
Falkof: For Morningstar, I'm David Falkof. Thanks for watching.