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Company Spotlights: 3Q22

Ahold logo

Koninklijke Ahold Delhaize N.V.

Koninklijke Ahold Delhaize N.V. (or “Ahold”) is a grocery chain with roughly half its business in the Benelux region of Europe (Belgium, the Netherlands and Luxembourg), and the other half in the US. In the US, the company owns ‘household name’ brands such as Food Lion, Stop & Shop, Fresh Direct and Peapod. The company was formed through the merger of Koninklijke Ahold N.V. and Delhaize Group SA in 2016. The large scale, complementary strengths and limited geographic overlap of the combined companies has driven strong synergies. Ahold’s solid execution and judicious investment spending have resulted in superior operating margins, excellent free cash flow generation and generous payouts to shareholders in dividends and buybacks. Ahold operates mostly through traditional supermarket formats and has been able to differentiate itself from competitors with its focus on high-quality fresh and private market label offerings. Instead of risky expansion, the company has focused on the regions and local markets where it has dominance.

Doing Well by Doing Good

Ariel initially made a small investment in Ahold almost a decade ago, when investors were focused on the company’s slower top-line and free cash flow growth. Meanwhile, we believed Ahold management’s plan to reinvest cost savings into more nutritional and affordable private label and organic foods would ultimately drive a defensible and sustainable franchise. We predicted that the company’s strategy to invest in fresher, better quality produce at affordable price points would not hamper margins – but drive market share gains and profit growth.

We took advantage of the significant weakness in Ahold’s shares and opportunistically bought most of our current position in the midst of overblown fears following Amazon’s acquisition of Whole Foods. We believed the transaction’s threats to Ahold were overestimated, and that Amazon was less experienced in managing a perishable supply chain. We thought it more likely that any market share loss to Whole Foods or others would be at the expense of smaller regional players, while leaders like Ahold would likely continue to benefit from internal initiatives and industry tailwinds.

Since our purchase, Ahold’s shares have recovered. The company continues to generate strong cash flow, higher than average operating margins, and maintains its #1 or #2 market positions in the regions it serves. Ahold’s returns on invested capital (ROIC) have remained highly attractive in the 15-20 percent range and have been generally stable for the majority of the last decade – relative to the high-single-digits ROIC that is typical of other industry participants. Ahold’s shares continue to generate a strong 3.5+ percent dividend yield with significant incremental return of capital to investors – atop the dividend shareholders already see in the form of share buybacks.

Work from Home = Eat from Home

Although this was not part of our initial investment thesis – Ahold became a major beneficiary of changed lifestyle patterns during the pandemic. As more people worked from home in the US and Europe, a larger share of food consumed came from grocery stores. Additionally, fears of contracting COVID-19 drove consumers to buy more of their food from one retailer, with fewer average shopping trips per week. This significantly benefitted large grocers like Ahold – which offers a large selection of product along with online ordering, pick-up and delivery services. Additionally, current market data suggests that Ahold is still retaining most of these share gains as people return to the office in 2022.

More Wellness and More Goodness: Ahold & ESG

Environmental, social and governance (ESG) research is fully integrated into Ariel’s International & Global investment process. Our portfolio managers are certified by the Sustainability Accounting Standards Board (SASB) – an institution that establishes industry-specific standards for the recognition and disclosure of material ESG impacts by public companies. During our initial research, we were impressed to find that Ahold has and continues to move forward with a range of progressive ESG initiatives.

These include:

  • Reducing food waste
  • Increasing the proportion of healthy private label products sold
  • Reducing scope 1 and 2 emissions
  • Promoting sustainable agriculture
  • Reduced packaging material with less plastic and more recycled material
  • Increasing the number of affordable products sold
  • Pursuing fair labor practices across Ahold’s supply chain
  • Improving product safety and quality
  • Increasing supply chain transparency
  • Quantitative diversity, equity and inclusion (DEI) metrics at both the corporate and store level
  • Initiatives focused on both customer and employee health and safety and well being

Ahold has tied more than 50 percent of its annual senior executive incentive compensation to progress on key ESG metrics. These measurements include: increasing the proportion of healthy food products sold, reducing food waste and reducing emissions.

In addition, the company includes its ESG Report in its financial statements. This means that Ahold’s reported ESG data is subject to review by its auditor.

Ahold remains an excellent example of a quality, stable business that continues to demonstrate remarkably high levels of profitability and social responsibility.

CarMax logo

CarMax, Inc.

CarMax, Inc. (NYSE: KMX) is the leading used-vehicle retailer in the United States with an unrivaled platform for buying, selling, and moving cars. The company’s brand, analytics, scale and cost advantages enable it to gain market share in any environment. Facing a slowing economy in the short term, CarMax rightly continues to invest for the long-term, leaning into its omnichannel strategy while competitors recede. For patient investors like Ariel, this industry heavyweight is uniquely positioned for outsized benefits.

Macro Concerns Weigh on the Short-Term Outlook

CarMax shares declined over 20 percent in late September after the company reported same store sales below the management team’s projected estimate. Broad inflation, climbing interest rates and low consumer confidence have caused a decline in sales. Vehicle affordability is a key headwind for consumers. With a ubiquitous brand name, well-known digital offerings, and facilities within 60 miles of most US car owners, CarMax has been gaining share in the face of this slowdown. Despite these gains, sales declined sharply as the summer progressed.

The Ability to Adjust to Customer Preferences

As the macroeconomic backdrop rapidly changes, the company is focusing on what it can control. On average, more than a third of CarMax’s vehicles are at least six years old, but the company has the unique ability to match demand, using its purchasing scale to procure wanted inventory. This is a competitive advantage. CarMax’s other key edge is its ability to provide credit seamlessly through a large captive finance operation in partnership with third-party lenders. A CarMax pre-qualification provides customers security in their ability to finance, without choosing a specific vehicle. On the sourcing side, CarMax’s instant appraisal and offer system help the company fill its inventory on solid terms.

Focused on the Long-Term Opportunity

As the leader in a large and highly fragmented market, there is an ongoing opportunity to gain market share. There are approximately 40,000 used vehicle dealers in the United States, but only a few players like CarMax can offer the full experience customers increasingly demand. For example, the company offers consumers the ability to move between physical and digital storefronts. The company continues to focus on the future – improving its already robust omnichannel experience and digital auction system. CarMax stands to gradually absorb share from dealers who cannot make these necessary investments. While CarMax’s investments have temporarily elevated its sales, general and administrative expenses, Ariel believes this strategy will ultimately drive market share gains and higher returns on invested capital in the long run.

We believe Wall Street is underestimating the value of CarMax’s brand and its growing digital and logistical capabilities. The company’s scale and solid cost management will help it deliver above-market growth and profitability. We expect CarMax to grow its annual sales volumes, improve operating margins and return excess cash to shareholders. As of September 30, 2022, shares traded at $66.02 – a 41.6 percent discount to our private market value of $113.03.

Generac logo

Generac Holdings, Inc.

Generac Holdings, Inc. (NYSE: GNRC) has been a leading global manufacturer of power generation equipment for the residential, commercial, and industrial markets since its founding in 1959. The company’s broad product offerings include: portable generators, engine-powered tools, industrial backup generators and more recently, solar storage and energy management solutions. Generac claims approximately 75 percent market share in North America for its core generator business. After several years of exceptional growth, the stock has been under pressure as investors grapple with higher interest rates and slower growth in the US. However, Ariel believes that Generac is uniquely positioned to benefit from growing demand for backup power, driven by more severe weather patterns and an aging power grid.

Reaching a Tipping Point

Until recently, residential standby generators had been a tough sell for homeowners. They were difficult to distribute, expensive, and only rarely needed. However, current events have caused a surge in demand. In 2019, California’s largest utility provider began implementing rolling power outages to prevent wildfires. In 2020, the pandemic turned homes into both sanctuaries and workplaces, amplifying the need for reliable power. And in 2021, Winter Storm Uri disrupted power to 4.5 million Texas residents. After barely budging for over two decades, Generac’s market penetration is on pace to double in the coming years. Given its dominant market share, the company has been the primary beneficiary of current trends, growing its sales over 30 percent annually and more than doubling its earnings per share (EPS) since 2018.

Monitoring Investor Enthusiasm

The stock has fallen over 60 percent from its peak last November as investors grapple with rising interest rates and the possibility of a global recession. With corporate valuation now back to pre-pandemic levels, we think the pendulum has swung too far. In its core home generator business, Generac entered the year with over $1 billion in services backlog and has quadrupled its manufacturing capacity to meet demand. Its often-overlooked commercial business has just scratched the surface on providing backup solutions to critical infrastructure – from wireless communication towers to hospitals. Most recently, the company has entered into the more nascent and complementary solar storage and grid services markets.

A Visionary Management Team

We believe Generac’s management team has been visionary. Over the past several years, the company utilized its strong balance sheet and excellent free cash flow generation to expand an unmatched distribution network. The company’s brand has become synonymous with reliable backup power. The Generac name also represents a unique solution for powering, storing and managing distributed energy for households and grid operators. With those investments in the rearview and its enviable competitive positioning, the company’s management team estimates that Generac has quintupled its addressable market. Now more than just a niche manufacturer, we believe Generac is uniquely positioned more broadly as an industry-leading solution to an aging electrical grid.

A Long Term View

At today’s valuation, investors have overly penalized Generac amidst today’s market volatility. As unbridled enthusiasm has shifted to overblown pessimism, we are taking advantage of an opportunity to own the leader in backup power generation. This is well-timed as the electrical grid proves to be ill-equipped to handle the electrification-of-everything. As of September 30th, shares traded at $178, a 46 percent discount to our private market value.

J.M. Smucker Company Logo

The J.M. Smucker Company

Founded in 1987 and headquartered in Orville, Ohio: The J.M. Smucker Company (NYSE: SJM or “Smucker’s”) produces some of America's most beloved consumer products. From pantry staples, to pet food, to coffee – the company’s market-leading brands like Folgers Coffee and JIF peanut butter – are found in nearly 90 percent of US households. Despite some acquisition-driven growth challenges over the years, Smucker’s stock price has recently performed extremely well. The company has been a prime beneficiary of both the recent work-from-home trend and investors’ appreciation of its consistency and pricing power amidst an uncertain economic environment.

A Refocused Strategy

Under its prior management team, Smucker’s struggled with an acquisition-led growth strategy. As a result, its performance trailed its peers and its stock price languished. However, new CEO Mark Smucker has divested non-core businesses and streamlined its number of products to refocus the business on its most successful and fastest-growing brands. The current management team brings a more prudent eye on capital allocation – continuing to look for tuck-in acquisitions, but only with the disciplined intent to complement the company's current portfolio.

Strong and Resilient Brands

The economic uncertainty arising from the pandemic has created a perfect storm of opportunity for Smucker’s. Consumer demand for at-home coffee and food brands increased dramatically during the crisis. With much of the workforce only slowly beginning to return to the office, that same tailwind should persist. More recently, rising inflation and recession fears have pressured consumer spending and punished more discretionary businesses. And yet, Smucker’s has been able to leverage its brands and pricing power to pass along rising input costs. As consumers seek to manage their budgets by eating at home, Ariel expects the company to continue thriving even if the economy weakens.

Returning Cash to Innovation (and Shareholders)

Despite the pandemic and the resulting economic uncertainty, Smucker’s has not stopped innovating. The company’s new partnership with Dunkin’ Donuts and investments in Uncrustables have been very successful – providing a long runway in its premium coffee and away-from-home food segments. In the pet category, Milk Bone and Meow Mix have been gaining market share. Beyond reinvesting for growth, the company is committed to returning excess cash to shareholders. Over the past ten years, Smucker’s has grown its dividend 8 percent annually and repurchased over $3 billion in shares. Going forward, the company aims to return 50 percent of cash flow from operations to pay down debt and return capital to investors through dividends or buybacks.

A Long-Term View

The markets have finally begun to appreciate our long-term view of Smucker’s, due to its refocused business and a bulletproof track record of pricing power and consistency. The company’s unmatched portfolio of market-leading brands is well-positioned for the long-term, regardless of the near-term macroeconomic uncertainty. As of September 30th, the stock traded at $137, a slight discount to our estimate of intrinsic value.

The companies highlighted in the Company Spotlights were held in one or more of the following Fund portfolios during the quarter ending 3Q 2022: Ariel Fund, Ariel Appreciation Fund, Ariel Focus Fund and Ariel International Fund. Investing in equity stocks is risky and subject to the volatility of the markets. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings or its strategy. Investing in small- and mid-cap stocks is more risky and volatile than investing in large-cap stocks. Investments in foreign securities may underperform and may be more volatile than comparable US stocks because of the risks involving foreign economies and markets, foreign political systems, foreign regulatory standards, foreign currencies and taxes. The intrinsic value of the stocks in which the Funds invest may never be recognized by the broader market. The Funds are often concentrated in fewer sectors than their benchmarks, and their performance may suffer if these sectors underperform the overall stock market. Ariel Focus Fund is a non-diversified fund and therefore may be subject to greater volatility than a more diversified investment. Investments in emerging and developing markets present additional risks, such as difficulties in selling on a timely basis and at an acceptable price. Investing in equity stocks is risky and subject to the volatility of the markets.

On this page, we candidly discuss four individual companies to illustrate our investment process. These companies are current holdings of certain Funds. The information and our opinions were current as of November 7, 2022 but are subject to change. The information shown does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. These securities do not represent all securities purchased or sold to investors during the period. Past performance does not guarantee future results. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of any Fund or of any particular Fund itself. Portfolio holdings are subject to change. Click here for the top holdings of the Funds.

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