Author: Bristlecone Value Partners
Model: Large Cap Value
In April, the model portfolio’s value rose by about 2.7%, slightly lagging the S&P 500 monthly increase. Year-to-date as of end of day 4/30/11, the portfolio is up about 9% versus 9.1% for the S&P 500, including dividends.
Most sectors rose in April, with utilities, telecommunications, and consumer staples leading the way. Consumer discretionary, financials, and materials declined. The portfolio’s top contributors to performance were NRG Energy (NYSE: NRG), Sprint (NYSE: S), and American Express (NYSE: AXP). The top detractors were Wells Fargo (NYSE: WFC), Harley Davidson (NYSE: HOG), and General Dynamics (NYSE: GD).
During the month, we sold our remaining investment in Home Depot (NYSE: HD), as the price reached our estimate of the company’s value. We did not buy or add to any position. Cash was about 5.8% as of 4/30/11.
In our March report, we discussed the different types of opportunities that value investors may seek: cyclicals at the bottom of the cycle, fallen angels, spin-offs, etc. We used Sprint as an example of a broken company with turnaround potential. This month, we look at an example of a cyclical business with the review of one of our top ten investments, Vulcan Materials (NYSE: VMC).
Vulcan is not a household name, but its products surround us. The company is among the largest producers of materials like crushed stone, sand, and gravel that are used in infrastructure projects such as highways, bridges, and to a lesser extent, in residential construction.
Investing in Vulcan requires patience, because the U.S. construction sector is still suffering from one of the worst downturns in history. And despite the economy showing signs of improvement, construction activity is still in the doldrums.
This said, we like Vulcan’s business and the company. During the downturn, aggregate pricing held up well, an indication that this is not the typical cyclical sector with irrational competitors. Getting new permits to mine for aggregates is difficult, costly, and takes a long time. Aggregates are also expensive to ship due to their high weight-to-value ratio. Consequently, we feel that Vulcan enjoys some solid competitive advantages.
Following the ill-timed acquisition of Florida Rock in 2007, the company has significantly reduced its costs, thereby increasing its operating leverage to a volume recovery. We expect such a recovery in the near future, which should in turn lead to a significant increase in operating margins and earnings.
Though the company is currently in weak financial health, it has some valuable and marketable assets. The balance sheet situation warrants monitoring, especially if the recovery in volumes fails to materialize in the next 12-18 months. Nonetheless, we continue to view an investment in Vulcan as having a very attractive risk-reward potential at its current share price.
