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Stock Stories: 1Q19


Anixter International Inc. (NYSE: AXE)

Founded in 1957, Anixter International Inc. (AXE) is a leading global distributor of electrical products used in communications, security, and power transmission. Customers outsource planning, procurement, delivery, installation, and technical support to Anixter. The company has the scale, supply chain capabilities, and reputation with customers to take advantage of key growth opportunities, such as the secular shifts to 5G communications and smart grid utilities infrastructure. Anixter’s share price declined last April after a large project the company had factored into its quarterly guidance was pushed into the following quarter. With economic activity decelerating, there is skepticism that Anixter can expand profit margins. This period of uncertainty has provided an opportunity to own this leading distributor at prices well below its intrinsic value.

Transitory Issues Cloud Underlying Progress

Since April 2018, when Anixter fell short of consensus expectations by inaccurately forecasting the timing of a large project, some investors have kept the company in the penalty box. Also, there is a new CEO, Bill Galvin, who took over from former CEO Bob Eck last year. Mr. Galvin has been with Anixter since 1984, most recently as President and COO, and we view his leadership favorably. Like many companies, Anixter has felt pressure on gross margins in the past year from increased freight and medical expenses, which it was initially slow to pass onto customers. Finally, there is skepticism that the company can achieve its long-term organic revenue growth targets. Our view is that Anixter is well-positioned for long-term trends in growth areas such as next generation wireless communications and smart grid infrastructure. In addition, Anixter is improving its training and data analytics, which should enable it to more efficiently assess and address customer needs.

The Drive for Operational Efficiencies

Anixter has begun to implement a plan expected to generate annualized pre-tax savings of $40-$60M by 2023. Despite a potentially meaningful improvement to margins, the market reaction to the plan has been muted, perhaps because of the long delay between implementation and expected results. The benefits of Anixter’s investments, which began in 2018, will not even begin to register in the financials until 2020. However, we believe the savings goal is achievable because many of Anixter’s warehouses, branch locations, and support functions have not been modernized. Addressing these areas should drive operational efficiencies and improve profit margins. In our opinion, the patient investors should ultimately be rewarded with enhanced returns.

An Opportunity For Long-Term Investors

As a top provider for contracted electrical networking, security, and utilities projects, Anixter is well-positioned for large opportunities that provide a runway for growth. In its largest segment, Network & Security Solutions, the company should benefit as it helps distribute the equipment that enables 5G. In its Utility Power Solutions segment, Anixter will likely play a key role in the smart grid infrastructure investment utilities will need to make in the coming years. With solid working capital management and attention to costs, Anixter should be able increase its asset efficiency and free cash flow generation. Its shares are trading 34% below our assessment of its intrinsic value.


CarMax, Inc. (NYSE: KMX)

Headquartered in Richmond, VA, CarMax is the largest used car retailer and one of the largest wholesale vehicle auctioneers in the US. Unlike some of its competitors, CarMax does not sell parts and repair services, which are typically profit drivers; however, its ability to offer financing compensates for this difference. The company began operations in 1993 as a subsidiary of now-defunct Circuit City, and was spun out of its parent as a publically traded entity in 2002. As of February 2019, the company maintains 203 stores, covering almost 75% of the country.

The Customer Experience

Historically, Ariel has had great success in investing in retailers that place an emphasis on the customer experience. In focusing on the customer experience, CarMax is known for its transparent no-haggle appraisal and selling process. CarMax salespeople earn commissions based on units sold, as opposed to unit profitability, aligning both party’s incentives and eliminating consumer distrust. The entirety of CarMax’s 56k+ used car inventory can also be viewed online and even shipped to a customer’s locale. Despite the simplicity of the model, many competitors have attempted to replicate it – and have failed.

Nimble with Significant Scale

While CarMax’s customer experience substantiates its brand equity, we believe its scale represents the heart of its differentiation. Having retailed and appraised more than 12.5 million and 28.5 million vehicles, respectively, while also controlling the third largest wholesale auction house in the US, CarMax has access to a tremendous amount of data that cannot be purchased by competitors. The company has developed a proprietary technology system that provides real-time information about many aspects of store operations: inventory management, pricing, vehicle transfers, wholesale auctions, and sales consultant productivity. As a result CarMax can be nimble, adjusting to various supply/demand trends while pricing accordingly to meet its profitability targets and minimize inventory writedowns. In our view, this expertise, coupled with prudent capital allocation, allowed CarMax to remain profitable through the Great Recession and translates into excess profitability vis-à-vis its competition.

An Omnichannel Approach

Despite this moat, the market has been concerned with CarMax’s ability to maintain its revenue growth trajectory and profit targets in the face of intensifying competition. Digitally-native upstart companies like Carvana aim to disrupt the status quo by eliminating pain points in the buying process and are taking share from smaller incumbents. Like all good companies, CarMax is not standing still. Much like traditional brick and mortar retailers, CarMax is taking an omnichannel approach and investing behind capabilities that will allow consumers to buy a car how and when they choose. Unlike its brick and mortar peers that are undertaking massive capital campaigns, CarMax already has robust data and distribution capabilities which means much of the heavy lifting has been done. Ultimately, a customer will be able to test drive, purchase, and finance a car without ever visiting a CarMax store. Lastly, CarMax is also facing pressure from new car dealers as the difference between new and used car prices have narrowed. We view this as more of a cyclical issue and take comfort in the company’s solid track record of performing in difficult environments.

If preliminary results from CarMax’s first omnichannel market in Atlanta are any indicator, the future certainly looks bright for the company. The stock is up since this encouraging news was reported at the end of March and we believe there is further upside from here.


Zebra Technologies Corporation (NYSE: ZBRA)

Founded in 1969, Zebra Technologies is a leading global supplier of asset tracking solutions. The company’s legacy business includes manufacturing thermal printers, which produce the barcodes used in managing global supply chains. Five years ago, Zebra acquired Motorola’s enterprise business, adding mobile computers, handheld scanners and cloud-based software to its offerings. Today its products are used by 95% of the Fortune 500 across industries such as retail, manufacturing, logistics and healthcare. Over the long-term, we believe there is no one better positioned to benefit from the growing secular demand for asset intelligence.

A Transformative Success

When Zebra acquired Motorola’s business back in 2014, CEO Gustafsson seized an opportunity to transform the business into a next generation solutions provider. At the time, investors had several concerns – the integration risk, the financial risk and the recent lackluster results of the acquired business. In hindsight, however, the long-term reward has far surpassed those shorter-term concerns. The integration is now complete, the debt load has been cut in half and the acquired solutions are now the fastest growing. Today’s Zebra is so much more than a niche barcode printer business. Its solutions have evolved from tactical productivity tools to mission-critical enablers of operational strategies.

More Than Just a Retail Story

More recently, investors have been overly focused on Zebra’s exposure to the retail industry. In 2016 for example, the stock price was cut in half as large brick-and-mortar retail customers responded to macroeconomic uncertainty by putting capital spending on hold. In our view not only was that view short-sighted – Zebra’s solutions are critical to creating a seamless omni-channel customer experience – but it ignored several other tailwinds that continue to propel the business today. For example, across all of its end markets, there are 10 million devices running Windows software that will no longer be supported by Microsoft in 2020. As the market-share leader in Android-based devices, Zebra is the beneficiary of that inevitable refresh. As another example, in healthcare, the number of nurses and physicians using mobile devices to administer patient care is expected to grow from 65% to 95% over the next 3 years. Zebra expects that part of the business, which has largely been ignored by investors, to be its fastest growing segment for the foreseeable future.

Free Flow Cash Machine

Zebra’s cash generating power has grown dramatically in recent years. This year, for example, the company expects to generate over $650 million in free cash flow. That growing cash hoard gives the company ample firepower to further accelerate growth. Its internal investment in research and development dwarfs its competitors – last year, the company released the most new products in its history. Acquisitions have been highly complementary and synergistic. And finally, with $1.5 billion in debt paid down since the acquisition and leverage below target levels, management is now free to look opportunistically at repurchasing its own stock.

A Market Share Leader

At current levels, investors are finally starting to acknowledge Zebra’s broad-based secular growth prospects. Yet even at these levels, we still see several areas where we believe investors are underappreciating nascent growth opportunities. Zebra Technologies is a rare example of a market share leader in a growing industry trading at an attractive price. As of March 29, 2019, shares traded at $209.53, an 8% discount to our private market value of $228.78.

Investing in small cap and mid cap stocks is more risky and more volatile than investing in large cap stocks. The intrinsic value of the stocks in which the Funds invest may never be recognized by the broader market.

On this page, we candidly discuss three individual companies to illustrate our investment process. These companies are current holdings of certain Funds, one of which was a top performer for the quarter, one was a new addition to a Fund, and the other was, in our view, undervalued by the market. The information and our opinions were current as of December 31, 2018, 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, sold, or recommended to investors during the period. Investors that were not invested in a Fund that held each stock for the entire holding period shown will not have experienced the performance shown. 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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