Down… but not necessarily out

Where will the market go next?

At Fort Pitt Capital, we describe our Individual Securities investment process as owning well run companies at reasonable prices and holding on to them. Our goal is competitive long-term portfolio returns, with overall volatility less than the market. As always, some names in the portfolio perform better than others in a given period. Over the past year or so, as the value segment of the stock market has lagged behind growth, we’ve seen our share of decliners. With this in mind, the following is a summary of our thinking on some of the “problem children” in the portfolio.*

SanDisk, Inc. (SNDK – down 43% ytd.) SanDisk shares have suffered from three consecutive earnings misses, reasons for which include poor execution on both a new product introduction and the Fusion-IO acquisition, which resulted in lower-than expected enterprise sales. We expect another weak quarter in the second quarter of 2015, with easier earnings comparisons putting a floor under the stock in the second half of the year. Management, which had a good operating record up until late 2014, will have a chance to fix any operating issues during this period, so that recovery can begin in 2016. We’re still quite bullish on the flash memory industry overall, and believe the problems at SanDisk are fixable.

Axiall Corp. (AXLL – down 23% ytd.) Axiall shares have lost about a quarter of their value year-to-date due to ongoing profit and cash flow disappointments. Management recently guided second quarter 2015 cash flow estimates down to levels approximating the first quarter, almost a 50% reduction from where sell-side analysts had been. Weak pricing for plastics used in building products has resulted in almost zero operating leverage for petrochemical producers like AXLL. We’ve held the shares because we believe the operating assets of the company are valued far too cheaply. Axiall operates in a very cyclical industry, and U.S. producers of commodity chemicals are cost leaders due to a significant raw material (natural gas) cost advantage.

NetApp, Inc. (NTAP – down 24% ytd.) NetApp shares declined after the company missed street earnings expectations for the final fiscal quarter of 2015. CEO Tom Georgens resigned shortly thereafter, and a new CEO has been hired. NTAP makes network-attached storage—big servers and disk drives that store data—either in a corporate data center or in the “cloud”. The cloud is a place on the public internet where data gets stored or a program runs. NTAP should be able to prosper in the cloud because its products are designed to work well with products from a variety of manufacturers. Storage sales have recently been weak across the industry, but we think this was an anomaly. Customers continue to create large amounts of data, and can therefore delay adding capacity for only so long.

Kinder-Morgan, Inc. (KMI – down 10% ytd.) Kinder-Morgan, Inc. shares have reversed a strong 2014 performance in 2015. Concerns about diminished opportunities for cash flow growth and excessive debt levels in a time of falling energy prices have left the shares about 10 percent lower. KMI operates the largest network of natural gas pipelines in the U.S. Managed since 1997 by Executive Chairman and founder Richard Kinder, the company has a history of steady and significant value creation for shareholders, of which Mr. Kinder is by far the largest. Recently reported second quarter results showed both a growing project backlog and cash flow sufficient to cover rising dividends, even after adjusting for lower energy prices. KMI has committed to growing their dividend by 10% each year from 2016 through 2020.

Joy Global, Inc. (JOY – down 32% ytd.) Joy Global is the last large, free-standing mining machinery company based in the U.S. JOY’s fortunes have fallen in recent years with those of coal miners, which have suffered in turn from cuts in coal-fired electricity generation. This trend, in combination with low natural gas prices, has driven the price of coal dramatically lower, making many mines uneconomic. Half of JOY’s business is underground mining equipment, tied mainly to coal. The other half is above-ground mining. While watching the steady decline in the price of coal, we’ve held the shares thinking they could be a candidate for a buyout.

Loews Corp. (L – down 7% ytd.) Loews shares have fallen due to concerns about weak operating results from two of their portfolio companies. The company operates CNA Financial, a commercial property and casualty company which has had strong results. Problems have come in the majority-owned Diamond Offshore Drilling (DO) and Boardwalk Pipeline Partners (BWP) businesses, which are hurting from the collapse in energy prices over the past year. Loews management has been adept at buying assets in the energy patch at distressed prices, and then holding them for long-term gains. These skills came into question last year, when the company sold its Highmount natural gas business at a loss. After generating financial returns that outperformed the S&P 500 for over five decades, Loews management faces an entirely new level of investor skepticism. That said, the company’s shares currently sell at about a 20% discount to the value of their publicly traded subsidiaries, minus all liabilities. We’re continuing to hold the shares.

Parker-Hannifin Corp. (PH – down 11% ytd.) One of the best managed firms in the industrial group as measured by total shareholder return over the past 20 years, Parker-Hannifin makes motion control equipment and other systems for various industrial and aerospace markets. The company has achieved 12 percent annual compound growth in sales since 2003, while rewarding investors with 58 consecutive years of dividend growth. After a flat 2014, Parker shares have dropped just over 10 percent in 2015. Investor concerns about the departure of longtime CEO Don Washkewicz in February may be holding back the stock. In his 43-year tenure with the company, Washkewicz oversaw a steady and substantial improvement in profitability. We think new CEO Thomas Williams, who joined Parker in 2003 after 22 years at General Electric, will continue the tradition of profitable operations.

Intel Corp. (INTC – down 12% ytd.) Intel shares have weakened as forecasts for 2015 personal computer sales have dropped from down mid-single digits to down high-single digits. Historically reliant on PC sales for growth, INTC has a path to wean itself from this reliance. This path includes making chips that use less electricity while maintaining high processing speeds. Why is this important? Competitors like ARM Holdings (ARMH) have had success selling low-power processors to mobile device makers, but it has come at a price—lower processing speeds. We believe that as the mobile device market matures and businesses look to make their workforces more mobile, the higher speed chips that Intel offers will be a necessity. Second quarter results, which came in ahead of expectations, indicate that INTC is gaining market share.

Texas Instruments, Inc. (TXN – down 7% ytd.) After returning better than 25% annualized over the previous three years, Texas Instruments shares have slipped back in 2015. In the nearly 2 decades that we’ve followed the company, TXN has evolved from a conglomerate with a diversified semiconductor business to an analog circuit company. Led by CEO Rich Templeton, the company has deemphasized baseband/cellular markets to focus instead on a diverse catalog of analog products and microcontrollers. Recent results have shown a minor slowing in both sales and profit momentum vs. 2014, but nothing out of the ordinary for a highly cyclical business.

Erie Indemnity Corp. (ERIE – down 5% ytd.) Another longtime Fort Pitt Capital holding, Erie Indemnity shares have stagnated in the $80 area for several years. This is nothing new for ERIE however. The stock went basically nowhere for five years between early 1996 and 2001, before nearly tripling over the next five years, resulting in a nearly 11 percent annualized total return for the decade. Sporting a 2.75 percent dividend yield, Erie shares have dipped about 5 percent in 2015. We like the company’s record of steadily growing book value over time in an industry ripe for consolidation, and will continue to hold the shares.

*For more information including all quarterly performance data for the firm’s managed portfolios, please contact the firm at

Nathan Boxx, Bradley Newman, Jason Seltzer

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