FPA Perennial Fund Q4 2013 Conference Call
On the negative side in terms of negative dollar contribution, L’Occitane International S.A. (HKG:0973) (FRA:COC), the health and beauty products company had the largest negative return even though it’s a fairly small weight within the portfolio. Unfortunately they had some same-store sales declines in Japan, and growth slowed down significantly in China. The two countries represent mid-teens of the total revenue of the company, and China had been one of the fastest growing economies for L’Occitane. So the market was not pleased with those results.
At this point, I’d like to turn it over to Eric where he’ll be discussing a couple of the truckload companies.
Eric: Last quarter we discussed a possible deal by one of the truckload carriers in our portfolio and the favorable consequences that might follow for us. We would like to bring the Perennial shareholders up to date on this and other similar activities.
The industry displays dynamic change. There are deals proposed and deals rejected. Government regulation gets tighter, and there are signs of a revival of industry demand. Looking specifically at the proposed unfriendly Knight acquisition of USA Trucks, the deal is neither on nor off. Progress, if any, is well concealed. Since we believe that the deal as proposed by Knight would have the potential to be highly beneficial, we find this absence of progress discouraging. The fact that the Knight offer has been $9 per USA Truck share and its recent price is about $14 is also disheartening.
However, there is a more positive outcome. Knight still expresses a willingness to negotiate, and increased offer price is a possibility. If the proposal ultimately goes nowhere, the result would be that USA Truck is replaced by a different target. Knight’s high operating margins, powerful balance sheet, and well regarded management are strategic assets which might be directed towards a different merger target with this similar ultimate effect.
As a consolation for our Knight problems, in mid-fourth quarter, Heartland Express, Inc. (NASDAQ:HTLD) announced a $300-million friendly purchase of Gordon Trucking, a deal which looks a lot like USA Trucks. The combined fleet will be the fifth largest in the industry, just ahead of Knight, with an operating ratio that is much in need of improvement and the promise of a geographic and cultural fit, which could help to make that improvement happen.
We continue to hold a substantial position in the truckload industry, currently about 7.5% of the portfolio. We see three ways to win here. First, strong managers with tracks records and capital structures to match can be expected to deploy and manage such assets to the ultimate benefit of shareholders. Second, it should be noted that there is a strong macroeconomic influence on truck transportation. The economy gets stronger; more trucks drive around. Continued economic recovery should continue to be a positive support to our portfolio position. And finally, just as increased demand benefits the industry, reduced supply also should be helpful.
What will be the cause of this? Well, numerous new federal tracking regulations are in the process of implementation. The best known are hours of surface rigs. These reduce hours per driving shift, as well as total hours driven per week. Other regs being added or enforced more stringently, including electronic logging devices, sleep apnea testing, traffic tickets, speed limiters, and drug testing methodology… when combined, we expect these changes to have the same impact as directly reducing the driver population and truck fleet. This effective reduction in industry capacity will pose operating challenges throughout the industry. But we expect that large well managed companies like Heartland and Knight will be best equipped to handle them.
Now I’d like to ask Steve Geist to talk about one of our portfolio holdings, CLARCOR Inc. (NYSE:CLC).
Steven: Thank you, Eric. Clarcor is a worldwide manufacturer of air and liquid filtration products. Some of their products go into heavy duty engine market, which is… those engines are used by the two companies that Eric was just speaking about. Clarcor has annual sales of over a billion dollars, and a large portion of their sales is actually replacement filters, which is a very high margin business.
In December, Clarcor completed the acquisition of General Electric Company (NYSE:GE)’s air filtration business. The annual revenue of this business is around $230 million. Purchase price was about $265 million. The benefit to Clarcor of this business was it provides Clarcor with exposure to the gas turbine filter business, which Clarcor had previously lacked. The gas turbines are used in power generation where they GE engines to generate the power.
Clarcor at the time of the acquisition had about $200 million of cash on the balance sheet, with minimum debt. It’s speculated that the acquisition could be funded about 50% cash and 50% debt. All those detailed haven’t been released as of yet. Depending on the exact financing arrangements and whether the filter business meets the growth objectives, estimates are that acquisition could be $0.20 accretive to Clarcor this year.
The primary competitor in the gas turbine filter business is a company called Donaldson Company, Inc. (NYSE:DCI), which is a former portfolio holding of ours. So we’re quite familiar with that company. Donaldson is a $2.5-billion revenue company, so it’s larger than Clarcor. But they will dominate the gas turbine filter business. Between the two of them, they’ll control roughly 40% of the market share.
Also as part of the acquisition agreement, Clarcor will continue to supply filters to GE’s turbine manufacturing business under a multiyear supply agreement.
Now I’ll turn it over to Greg to talk about Signet Jewelers Ltd. (NYSE:SIG).
Greg: All right, thank you, Steve. The last company we want to talk about today is Signet Jewelers, and this is a business we’ve discussed many times before. But very briefly, the company operates jewelry chains in the U.S. and the U.K. A little more than 80% of the operating profit comes from the U.S. And you might recognize their two biggest chains in the U.S., Kay Jewelers and Jared.
So we wanted to talk about three things today with Signet. The first is how they go about sourcing the diamonds that they sell. The second topic is their holiday sales recap. And then third is an activist hedge fund has taken a stake in Signet, and that was a recent announcement. We wanted to talk about that for just a minute.
So starting with diamond sourcing, we went back and looked at, over the last 12 years, the industry’s trends in supply and demand for diamond stones. And diamond jewelry sales grew faster than supply in nine of those 12 years. If you look ahead over the next few years, the industry is forecast to grow mid single digits in terms of the demand. At the same time, supply growth is likely to be flat over that time period. So we think the result is going to be upward price pressure on diamonds. And typically