Value Investing

Bretton Fund 2Q15 Shareholder Letter: Valspar, Nordson, MEDNAX

Bretton Fund letter to shareholders for the second quarter ended June 30, 2015.

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Dear Fellow Shareholders:

The Bretton Fund’s net asset value per share (NAV) as of June 30, 2015, was $25.83. The fund’s total return for the quarter was 1.41%, while the S&P 500 Index returned 0.28%. The total return for the fund for the first half of 2015 was 0.43%. Over the same period of time, the total return for the S&P 500 Index was 1.23%.

Total Returns as of June 30, 2015

2nd Quarter First Half 2015 1 Year (A) Annualized
3 Years (A)
Annualized Since
Inception (A)
Bretton Fund 1.41% 0.43% 10.68% 12.60% 13.81%
S&P 500 Index (B) 0.28% 1.23% 7.42% 17.31% 15.71%

(A) 1 Year, 3 Years and Since Inception returns include change in share prices and, in each case, include reinvestment of any dividends and capital gain distributions. The inception date of the Bretton Fund was September 30, 2010.

(B) The S&P 500 is a stock market index based on the market capitalizations of 500 leading companies publicly traded in the US stock market, as determined by Standard & Poor’s, and captures approximately 80% coverage of available market capitalization.

Performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end here or by calling 800.231.2901.

All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. The fund’s expense ratio is 1.50%. The fund’s principal underwriter is Rafferty Capital Markets, LLC.

Bretton Fund - Contributors to Performance

The largest contributor to performance was our position in the large banks (Wells Fargo, JPMorgan, and Bank of America), which contributed 1.2% to the fund’s performance as more evidence emerged of the health of the US economy. We gained another 1.0% from our small manufacturer of hurricane-resistant windows, PGT, which successfully integrated a merger and is benefitting from an improved housing market in coastal Florida. Our healthcare investments IPC and Community Health Systems each contributed 0.5%: IPC benefitted from a shift toward outcomes-based payments by Medicare, and Community Health Systems was helped by the Supreme Court verdict upholding the Affordable Care Act.

The largest detractors from performance were the railroads (Union Pacific, CSX, and Norfolk Southern), which collectively cost us -1.1% on the heels of declining coal volumes, and Ross Stores, which cost us -0.6%.

Bretton Fund - Portfolio

Security % of Net Assets
Wells Fargo & Company 11.0%
Ross Stores, Inc. 7.0%
Union Pacific Corp. 6.5%
PGT, Inc. 4.8%
Valspar Corp. 4.2%
American Express Co. 4.2%
Armanino Foods of Distinction, Inc. 4.1%
AutoZone, Inc. 4.1%
Discovery Communications, Inc. 4.0%
Flowserve Corp. 3.9%
JPMorgan Chase & Co. 3.8%
MasterCard, Inc. 3.7%
Nordson Corp. 3.5%
Bank of America Corp. 3.5%
CSX Corp. 3.4%
IPC Healthcare, Inc. 3.3%
Carter’s, Inc. 3.1%
Community Health Systems, Inc. 2.9%
MEDNAX, Inc. 2.8%
The Gap, Inc. 2.3%
New Resource Bank 1.6%
Aflac, Inc. 1.5%
T-Mobile US, Inc. 1.4%
NexPoint Credit Strategies Fund 1.3%
Norfolk Southern Corp. 1.2%
NexPoint Residential Trust Inc. 0.8%
Cash* 6.0%

*Cash represents cash and other assets in excess of liabilities.

We exited three companies in the quarter: Coach, America’s Car-Mart, and Standard Financial. Our total loss on Coach was -22.0%, which was -13.3% on an annualized internal-rate-of-return (IRR) basis, our weakest investment to date. While its international business was strong, we underestimated how vulnerable its US business was to competition, and we no longer see a clear path to a Coach resurgence in a reasonable time frame. Car-Mart’s total gain was 19.4% and IRR 8.5%, a decent return, if not a bit disappointing in the context of alternative investments. Car-Mart continued to grow its business nicely, but the relaxation of consumer lending standards from third-party lenders created the toughest competitive environment in its history soon after we bought in. Standard Financial, our last remaining thrift conversion, returned 48.5% for an IRR of 10.1%, a good return given the low risk of the investment.

The fund initiated five investments during the quarter: Valspar, AutoZone, Nordson, MEDNAX, and T-Mobile.

Bretton Fund - Valspar

Valspar is best known for its paints sold at Lowe’s and Ace Hardware. The US paint market is fairly consolidated, with Sherwin-Williams and PPG dominating the professional category and Valspar and Masco leading the do-it-yourself (DIY) charge through Lowe’s and Home Depot, respectively. (A fifth player, Berkshire Hathaway’s Benjamin Moore, sells through independently owned franchised stores.) In December Lowe’s announced that it would move away from its Lowe’s-branded/Valspar-made paint and bring in an HGTV-branded line from Sherwin-Williams. While Valspar still sells its Valspar-branded paints at Lowe’s, the loss of revenue led some to question the company’s prospects.

Paint as a whole only represents about a third of Valspar’s revenue. The bulk of the company’s revenue, and even more of its profits, comes from industrial coatings—paint for things that aren’t obviously painted, e.g., the metal insides of food and beverage cans are coated to prevent interaction with food contents. Traditionally, this was accomplished with coatings containing bisphenol A (BPA), which turns out to be an endocrine disruptor with potentially harmful health effects. The US Food and Drug Administration has banned BPA from products for infants while reviewing its appropriateness for general use, and France has gone ahead and banned it altogether. As it happens, Valspar is the leading manufacturer of BPA-free food coatings.

We expect Valspar to weather the Lowe’s transition; its paints are selling well in other channels, and the non-decorative coatings business is booming. We own a growing, cash-generative consumable products company that pays out that cash to investors.

Bretton Fund - AutoZone

AutoZone is the largest retailer of auto parts, with nearly $10 billion of revenue across its 5,070 stores in the US and 420 stores in Mexico. For the past 15 years, AutoZone has followed a steady, lucrative formula: it has taken 2.5–3% sales-per-store growth, combined it with 2.5–3% store growth, and generated revenue growth of about 5.5%. Through economies of scale, including squeezing its vendors on price and payment terms, it has converted this to 7% operating-income growth and generated a torrent of cash flow that it has used to aggressively buy back its own shares, the effect of which is pretty powerful: that 7% annual operating-income growth led to 18% annual growth in earnings per share.

One concern that has weighed on the company is that it is increasingly difficult for AutoZone, with over 5,000 stores in the US, to find 150 new sites each year that are not already well-served by an existing AutoZone. Another is the shift away from the DIY sector—consumers who buy a product that they plan to install themselves, the core of AutoZone’s business—to the do-it-for-me (DIFM) sector—professional mechanics, a market that AutoZone historically hasn’t focused on. Today’s cars are far more complicated than the cars of even 20 years ago, with the effect that an increasingly small percentage of the population has the ability or inclination to tinker with cars. These concerns may end up having the same solution: AutoZone is moving aggressively to build its DIFM business by using its existing store and distribution center footprint to also serve mechanics. It is a small player in the DIFM market today, but its early efforts have gone well. It has an unrivaled nationwide network and the ability to compete with any other vendor.

Another item of note is the changing fleet