Conservative Allocation Strategy : Commentary

Portfolio Manager: Bradley Hinton

As of 3/31/2016

The Moderate Allocation Strategy’s asset allocation was 47% stocks, 36% bonds and 17% residual cash at quarter end. Our fixed income investments remain focused on shorter maturity, higher-quality cash flows. At current valuations the Strategy’s future return potential is heavily skewed to the stock portion of the portfolio, while the bonds and cash primarily provide stabilization.
The Strategy returned +1.97% (gross of fees), +1.69% (net of fees) during the first quarter, compared to +1.88% for the Blended Index (60% S&P 500® + 40% Barclays Intermediate U.S. Government/Credit Index).  For the trailing twelve months, the Strategy returned +0.31% (gross of fees), -0.80% (net of fees) compared to +2.14% for the Blended Index.

Fiscal Year Contributors

Martin Marietta Materials is a producer of sand, gravel, aggregates and cement (products for the construction industry). During the trailing twelve months, Martin’s aggregates volumes, pricing, and incremental margins exceeded investor expectations, as non-residential and public construction showed broad-based strength. The outlook for public volumes over the next several years improved with the passing of the 5-year federal highway bill, dubbed Fixing America’s Surface Transportation (FAST) Act, and with state Department of Transportation budgets expanding. Martin also increased, for the third time, its synergy cost-savings target for the 2014 Texas Industries acquisition from the original $70 million to $120 million. They sold their California Oro Grande cement operation for $420 million the proceeds of which will be used towards their 20 million share repurchase program. The culmination of these positive events pushed Martin Marietta’s stock price above our estimate of intrinsic value, and we exited our position during the third quarter of 2015.
Alphabet is a multinational technology company generally specializing in Internet related services and products.  Alphabet’s core search business (Google) delivered strong operating results which eased investor fears that the company’s primary search advertising products would not be as relevant on mobile phones as on desktops.  Alphabet’s shares rose, as investors priced in a higher rate of long-term growth, renewed operating expense discipline and the announcement of the company’s first capital return program. We opportunistically trimmed our position, as the stock price approached our estimate of business value.
Accenture is a leader in providing management consulting, technology and outsourcing services.  Accenture share price appreciation reflects the company’s consistent execution of assisting its clients in adopting digital transformation strategies while maintaining strong free cash flow generation and return of capital.   

Fiscal Year Detractors

Range Resources is an independent producer of natural gas and natural gas liquids (NGLs) based in Fort Worth, Texas.  Despite a healthy rebound during the first calendar quarter, Range shares remain well below last year’s levels thanks to stubbornly low natural gas and NGL prices.  Following one of the mildest winters in recent memory, the one-month New York Mercantile Exchange (NYMEX) natural gas futures contract settled in early March at $1.67/MMBtu, its lowest level since 1999.  While we cannot predict the timing of a recovery in natural gas prices, the present state of oversupply is unlikely to be permanent.  Domestic drilling and completion activity levels are now nearing record lows, with even the industry’s most efficient players pulling back (Range is down from 15 active drilling rigs to three).  In the meantime, the company’s balance sheet has improved (via the monetization of non-core assets), it is drilling more efficient wells and its cost structure has continued to fall (finding and development costs are trending toward $0.20/Mcfe).  We expect Range to emerge from the downturn in position to generate attractive per share cash flows in the years ahead.
Express Scripts  Please refer to the Quarterly synopsis.
Liberty Global is the largest international cable company, with operations in 14 countries providing video, broadband Internet, fixed-line telephone and mobile services to its customers.  Liberty Global’s portfolio of businesses produced mixed results during the fiscal year.  Continued strong results in the UK and Belgium were partially offset by continued competitive pressures and merger integration missteps in Holland, and a poorly received price increase in Germany. Furthermore, the continued strengthening of the US Dollar put a damper on Liberty’s results (reported in US Dollars).  We believe the company is restoring investor confidence by learning from these missteps, taking actions within the portfolio as needed (e.g., moving the Dutch business into a joint venture with Vodafone-See Quarterly Detractors) and outlining an achievable three-year growth plan.

Quarterly Contributors

Range Resources is an independent producer of natural gas and natural gas liquids (NGLs) based in Fort Worth, Texas.  Range shares rallied during the quarter, as the company reduced its debt load by roughly $1.0 billion following the divestiture of two non-core assets (Nora and Bradford County).  The company is continuing to pursue a sale of its central-Oklahoma oil properties, which will likely be used to retire additional long-term debt. Other positives included improving natural gas price sentiment (for 2017) and a general thawing in the high yield debt markets. Falling drilling activity in the Marcellus and Utica shales (collective rig counts are down from 170 at peak to 40 at present) and the continued drop in domestic oil production, in time, should bring both oil and natural gas prices up closer to their marginal costs of production.  In the interim, Range has 80% of its 2016 gas production hedged at $3.24/MMBtu and is locking in additional 2017 production with the current gas strip close to $2.85.  We continue to believe Range will emerge from the downturn a significantly more efficient–and more valuable–company.          
FLIR Systems is a global leader in infrared and thermal imaging equipment for military and commercial end markets. During the quarter, FLIR benefited from a surge of government orders, which elevated company-wide backlog to the highest level since 2008 (up 6% year over year). Recent high-profile terrorist attacks in Brussels and Paris along with unrest across the Middle East have also led to heightened expectations for FLIR’s surveillance and detection equipment going forward.  Finally, many investors fearing a slower Europe and a drop off in activity in Brazil and China, expected contraction in FLIR’s thermal instruments business during the quarter; however, FLIR reported flat results in the fourth quarter and 5% growth for the full year. North America held up well and China reported solid growth, as preventative maintenance takes hold in Chinese utilities and industrial companies.
Berkshire Hathaway is a conglomerate holding company owning subsidiaries engaged in a number of business activities. Berkshire shares were helped by the closing of the Precision Castparts acquisition and improved operating performance at its Burlington Northern railroad subsidiary. Berkshire’s insurance unit continues to show excellent discipline in underwriting, which results in temporary declines in premium, but means the company will have significant capacity when insurance pricing returns.

Quarterly Detractors

Express Scripts is the largest stand-alone pharmacy benefits manager (PBM) in the United States, helping health benefit providers improve access to (and the affordability of) prescription drugs.  Negotiations with Anthem, Express Scripts’ largest customer, hit an impasse early in the quarter.  Anthem elected to bring the details of the disagreement public at a widely attended industry conference in January, providing the investment community a lens into how far the two companies were apart on the economics of their existing contract.  Since then, Anthem has also filed a lawsuit against Express Scripts.  While we hope a mutually agreeable solution will eventually be achieved, it remains possible (some believe likely) that Anthem will choose not to renew its contract with Express in 2019. We have run scenarios encompassing a range of different outcomes, and we believe Express Scripts’ shares are undervalued in all but the most dire.  We continue to monitor contract-related developments and are otherwise heartened by improved execution across the other 84% of Express Scripts’ enterprise.
Liberty Global is the largest international cable company, with operations in 14 countries providing video, broadband Internet, fixed-line telephone and mobile services to its customers. Its shares price fell early in the quarter after an influential Wall Street analyst downgraded his outlook for the stock, principally due to concerns over continued competitive struggles in Holland (one of Liberty’s largest markets).  Since that time, Liberty announced it would move its Dutch operations into a 50/50 joint venture with Vodafone.  The joint venture structure allows Liberty to combine its strong cable and broadband businesses with Vodafone’s mobile offering to create a more competitive, “converged” offering.  Liberty also provided Wall Street with an attractive three-year growth outlook during its fourth quarter earnings call, helping shares recover some of the earlier declines.  We remain confident of continued growth for Liberty’s cable offerings and management’s abilities to deliver on their outlook.
Monsanto is a provider of seeds and biotech traits for corn, soybeans and cotton. Monsanto faced a number of headwinds in the first quarter, most notably soft commodity prices, the devaluation of the Argentine Peso and the increasing unlikelihood of large scale M&A. Add weak glyphosate pricing and intense competition in seeds, and the stock is facing what some might call a perfect storm. In fact, US farm income is forecast to be a 13-year low. We remain bullish on Monsanto long term because it’s the highest quality franchise in agriculture. It has 35% share of the US corn seed market, a defensible yield advantage over its peers, and the deepest pipeline of R&D and technology in the industry by far. The company has a path to double-digit earnings growth through 2019 via self-help initiatives, which aren’t reliant on corn prices recovering (although such an event would certainly be welcome).

New Holdings

Allergan is a global specialty pharmaceutical company focused on the development, manufacturing, marketing and distribution of generic, brand name, biosimilar and over-the-counter pharmaceutical products.  Formerly Actavis, the “new” Allergan is a collection of significant acquisitions made over the past 4-5 years, including Watson Pharmaceuticals, Warner Chilcott, Forest Laboratories and legacy Allergan.  During the summer of 2015, Allergan announced the divestiture of its global generics business to Teva at a terrific price ($40.5 billion).  While closing has been delayed approximately three months by the Federal Trade Commission review, we believe the Teva transaction will ultimately be approved.  Allergan should then emerge as a pure-play branded pharmaceutical manufacturer with the potential for high single-digit, organic growth and significant balance sheet optionality. 
Comcast is the largest operator of cable delivered Broadband and Pay-TV service in the United States and, through its NBC Universal subsidiary, is a global entertainment company.  After abandoning its bid to acquire Time Warner Cable, Comcast has refocused on execution in its core cable business–investing in higher broadband speeds and introducing a new best-in-class user interface for its Pay-TV customers (dubbed X1).  The Company is aggressively rolling out X1 across its footprint, driving higher customer satisfaction and improved customer retention.  At NBC Universal, results continue to positively surprise investors thanks to box office hits like Jurassic World, and new attractions like The Wizarding World of Harry Potter driving record attendance at its theme parks.  Despite investor concerns over “cord cutters” and “skinny bundles,” we believe the Pay-TV business is more resilient than feared, and thanks to its position in broadband and content, Comcast is well positioned for the future. 

Eliminated Holdings

Precision Castparts - We sold Precision Castparts at a gain when Berkshire Hathaway completed its acquisition of the company.
Brown & Brown - We sold Brown & Brown at a modest gain when the stock exceeded our revised business value estimate.
Omnicom Group - We sold Omnicom Group at a healthy gain when the stock approached our business value estimate.
Core Laboratories - We sold Core Laboratories at a modest loss to focus our energy investments in much cheaper exploration and production (E&P) companies.


Quarterly Top Performers

Range Resources Corporation
FLIR Systems, Inc.
Berkshire Hathaway Inc. Class B
Aon plc
Motorola Solutions, Inc.

Quarterly Bottom Performers

Express Scripts Holding Company
Monsanto Company
Liberty Global plc Class C
Liberty Interactive Corporation QVC Group Class A
Laboratory Corporation of America Holdings
Contributions to performance are based on actual daily holdings. Securities may have been bought or sold during the quarter. Return shown is the actual quarterly return of the security or combination of share classes. Source for return shown is FactSet Portfolio Analytics. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. The holdings identified do not represent all of the securities purchased, sold or recommended for Weitz Inc.’s advisory clients. Contact Weitz Inc. to obtain the methodology for the calculations above. You may reach Weitz Inc. at 1125 S 103rd Street, Suite 200, Omaha NE 68124, at 1-800-304-9745 or at

Performance information in this letter is the weighted-average performance of accounts managed by Weitz Investment, Inc. (“Weitz Inc.”) under its Moderate Allocation Strategy (the “Strategy”). Performance of particular securities in this letter is shown for an entire time period. All other portfolio holdings information is for a particular “Representative Account” in the Strategy.

Index performance is hypothetical and is shown for illustrative purposes only. The returns above also include fee waivers and/or expense reimbursements, if any; total returns would have been lower had there been no waivers or reimbursements. Contributions to performance are based on actual daily holdings. Comparative returns are the average returns for the applicable period of the Blended Index. The Blended Index blends the S&P 500 with the Barclays Intermediate U.S. Government/Credit Index by weighting their total returns at 60% and 40% respectively. The portfolio is rebalanced monthly.

Investors should consider carefully the investment objectives, risks and charges and expenses of the Strategy before investing. Past performance does not guarantee future results. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk.