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Auxier Report: Summer 2021

Jun 30, 2021

Download Auxier Report Summer 2021

Summer 2021 Market Commentary

The market and economy continued a strong rebound during the second quarter as COVID restrictions eased further. The 7-day moving average for new COVID cases in the US recently reached its lowest level since the start of the pandemic. However, the spike in the Delta variant is adding headline uncertainty. Economic growth has been strong thanks to vaccine distribution efforts, businesses reopening and emergency fiscal and monetary stimulus. JPMorgan estimates full-year US GDP growth of around 6%, the highest since 1984. The ten-year treasury bond yields less than 1.5%. Back in 1984 we were buying Washington State general obligation bonds yielding 10% when the GDP had similar readings. Retail sales are 20% higher than pre-COVID levels, indicating strong consumer spending and sentiment. Back-to-school spending should be  boosted with the liberalized Child Tax Credit (CTC). Nearly 70% of US economic growth is tied to consumer spending. The housing market fundamentals are benefiting from record low mortgage rates, surging demand from millennials, buy-to-rent institutions, foreign buyers and Airbnb conversions. In addition, the pandemic and technology advances enabled millions to work at least part time from home, adding unanticipated demand from the migration out of the major cities. Home equity values now exceed $22 trillion.

We continue to meet with numerous management teams and see powerful earnings on the back of companies that have scale and have been aggressively digitizing, with a focus on improving the customer experience. The pricing power has been the strongest I have seen in my career across most industries. Surprisingly, margins have held up as well.

Inflation

The pandemic put a strain on global supply chains which has resulted in dramatic price increases in the shipping container space. According to research from Sea-Intelligence, the average price to ship a 40-foot container has increased by more than fourfold to $8,399 as of July 1. Some short-term rates have exceeded $25,000. Global vendors like Amazon cannot afford to delay their shipping in hopes of better rates and so they have been forced to pay these elevated prices, which has boosted global shipping companies. The leading  container company Textainer  has had tremendous operating results. Philip Damas, head of supply chain advisory at Drewry, expects that the strains on the container shipping industry will remain in place until early 2022. Ironically, just as consumers get used to online shopping, the cost of transportation is soaring.  The American Trucking Association projects a shortage of 100,000 drivers by 2023. Numerous CEOs are echoing the price pressures that seem to be accelerating. Unemployment benefits have been so attractive that it has been difficult to motivate workers to return, prolonging bottlenecks.

The ongoing microchip shortage has caused the used car market in the US to heat up as new car inventory in the US was 54% lower in June 2021 versus June 2019, which has boosted demand for used vehicles.  Prices are up 40% more than in February of 2020 before the peak of the pandemic. The average 9-year-old vehicle sold for $13,250 in June, which is approximately up 30% over June 2020. Microchips are a critical component of nearly every electronic device in the world so the shortage of new cars could continue for some time.

So far, we are seeing most businesses raise prices and consumers willing to pay up. This has contributed to a tremendous broad-based earnings improvement for our portfolio companies.

The dollar has depreciated over 85% the past 50 years. Purchasing power risk is hidden as people mistakenly perceive safety in fixed income. Today we are seeing negative real yields all the way out 30 years as inflation is running over 5.3%. Owning businesses is a better bet. However, you can’t just pay any price for stocks as higher inflation tends to compress P/E ratios. In 1972,  conventional wisdom was to simply buy the 50 most popular stocks known as the “Nifty Fifty.” The idea was to buy, hold and forget. In the frenzy the stocks traded over 80 times earnings on average. Then, despite strong earnings, a surge in oil and  inflation crushed valuations leading  to a 70%-90% decline for the group. A good general rule for a market multiple  has been 20 less the inflation rate. In 1979, with 11% inflation the P/E of the market sunk below 10.

It appears the current inflation is understated, especially if you add back energy, food  and housing which are all excluded. The consumer price index (CPI) only includes the rent component of housing; however, rents are now catching up too. Invitation Homes, the largest single-family landlord in the nation, recently boosted rents by 8% across the country. Back in the 1970s, Fed chairman Arthur Burns claimed that rising inflation was nothing to worry about—it was  “transitory” and best ignored. When oil quadrupled, they solved the problem by taking oil out of the index. Food prices, a 25% weighting, soared and were also removed. So was housing, a 16% weight. The Dow hit 1,000 in 1972 and was flat until 1983. As cost price pressure hits, consumer wage expectations and compensation demands go up, which are hard to reverse–especially in areas difficult to digitize like skilled labor. Historically, government intervention in the form of wars, extreme socialism and confiscations have contributed to supply disruptions and higher inflation. After the American Civil War, inflation drove interest rates to 20%. When Zimbabwe confiscated private farms their inflation soared 3000%. As Venezuela nationalized most of their businesses inflation exceeded 500%. Inflation in Argentina recently gained 70% as the government interrupted free markets and politics moved to the extreme left. Domestically, recent bans on natural gas turbines and pipelines have led to a reduction in fossil fuel capital investment which should contribute to higher sustained power prices. Over the years, societies with free market competition and innovation have generally kept inflation in check. However, heavy-handed socialism is a recipe for more permanent price increases. The potential for the Delta variant could further extend the interruption in supply chains.

Companies That Can Thrive During Inflationary Periods

When I started in the business, inflation was one of the biggest headline worries. I initially went back over the prior 80 years and studied the types of businesses that could survive, thrive and outperform during high inflation. Generally, undervalued companies that had powerful brands with freedom to price, consistent and growing demand, rapid inventory turns and high returns on invested capital with low mandatory capital expenditures tended to outperform. Drug stores and supermarkets with low ticket necessities were notable winners. Investment selection becomes much more important as higher inflation can put a lid on valuations. Often markets can become rangebound and can go flat for years. In 1983 when the Dow rallied to 1,000, I remember experienced investors wanting to sell out as the market had been stuck in a narrow trading range for the prior 18 years with 1,000 the top. A higher inflationary environment  is not a friendly environment for the “growth at any price” momentum approach. Making an exceptional buy becomes much more important as inflation acts as a headwind to breakout valuations.

Kroger Shows Confidence Amid Fears of Rising Inflation

Kroger is an example of an inexpensive (13 P/E), low expectation stock that has survived well during periods of higher inflation. The company turns over inventories 14 times a year, which helps to maintain a high return on invested capital and pricing power. They recently recorded another strong quarter and beat consensus estimates for both revenue and non-GAAP (generally accepted accounting principles) EPS. Kroger has been able to maintain their momentum despite the lifting of pandemic restrictions and restaurant re-openings. Digital sales continued to grow, up 16% on the quarter and 108% over the last two years. Due to their success this quarter, the board announced a new $1 billion share repurchase program. Management also raised their guidance for full-year 2021 adjusted EPS to $2.95-$3.10, up from their previous guidance of $2.75-$2.95. Since Amazon’s acquisition of Whole Foods in 2017, some investors have feared that Kroger would begin to lose market share to the e-commerce giant. The pandemic has  bolstered their position as a leader in the US grocery market with an 11.7% share. Despite all the fear surrounding Amazon’s Whole Foods purchase, they have only been able to amass a market share of 2.6% since entering the grocery space. Management has also addressed fears that future inflation could dampen growth, stating that they operate at their best when the inflation rate is around 3%-4% and more shoppers move away from large brands, opting for Kroger’s lower-cost private label options. Kroger also continues to build their Ocado automated warehouses that will greatly enhance the company’s delivery capabilities and allow them to better compete with e-commerce giants like Walmart and Amazon. In addition, they are well positioned to benefit from the robust back-to-school market this fall.

Reality of Automation in the Auto Industry

The advancement of AI technology has increased interest in developing self-driving cars and has led to over $120 billion in investments from 2017 to 2019, according to research from McKinsey. Companies like Tesla, Uber and Lyft have bet big on driverless technology, but it may take longer than expected before fully autonomous vehicles are available to consumers. Elon Musk, CEO of Tesla, recently stated that creating AI programs that can adapt to complex roadways and unpredictable human drivers has proven to be a greater challenge than they originally thought. Tesla is still committed to the technology as they continue to test an advanced beta version of their self-driving software that Musk believes could one day solve the challenge of autonomous vehicles without the use of expensive lidar and radar sensors. Companies like Alphabet’s Waymo have been able to achieve fully autonomous vehicles using lidar sensors and highly detailed maps of specific areas around Phoenix, Arizona. However, this approach will likely be difficult to scale and could be cost-prohibitive for the average consumer. It remains to be seen if these challenges will be solved any time soon, and companies may be better off investing in safe and effective driver assist systems until AI technology advances further. McKinsey also estimates that any company that intends to remain competitive in the driverless car market could potentially have to invest $70 billion through 2030. As always, talk is cheap, and  it is important to look past the hype and focus on execution.

Value Potential

In 2000, Yahoo and AOL were two of the most exciting technology stocks that were going to transform the world. In the dot com mania they reached a combined valuation in excess of $250 billion. This year Verizon sold both companies to Apollo Global Management for $5 billion—a 98% decline. AT&T acquired DIRECTV for $49 billion in 2015 and recently sold 30% of the business for $1.8 billion. Overpaying and overborrowing are the recurring sins that consistently destroy shareholder capital. Just like in 2000, the spread between the cheapest and most expensive stocks is now one of the widest in history. Historically, the Russell 1000 Growth Index trades at a 5.6 times point premium over the Value Index but is currently trading at a 10.3 premium. We expect a reversion to the mean, especially if the economy broadens and inflation continues to rise.

Second Quarter 2021 Performance Update

Auxier Focus Fund’s Investor Class returned 4.91% in the second quarter vs. 8.55% for the cap-weighted S&P 500 Index and 5.08% for the DJIA. The equal-weight S&P 500 returned 6.90%. Small stocks as measured by the Russell 2000 were up 4.29%.  The MSCI Emerging Markets Index gained 5.05%. A 60/40 S&P 500 and Bloomberg Barclays US Aggregate blended index returned 5.84% and bonds, as measured by the Bloomberg Barclays US Aggregate Bond Index, returned 1.83% for the quarter.

Stocks in the Fund comprised 96.3% of the portfolio. The equity breakdown was 85.1% domestic and 11.2% foreign, with 3.7% in cash and short-term debt instruments. A hypothetical $10,000 investment in the Fund since inception on July 9, 1999 to June 30, 2021 is now worth $53,206 vs. $46,591 for the S&P 500. The equities in the Fund (entire portfolio, not share class specific) have had a cumulative return of 775.05% since inception and the Fund as a whole has had a cumulative return of 432.05% vs. 365.91% for the S&P. This was achieved with an average exposure to the market of  80.6% over the entire period.

Contributors to the quarter:  Our outlook on a cross section of positions with a positive impact on the portfolio for the quarter ended 6/30/2021.

Microsoft Corporation (MSFT)
As a tech-focused company, Microsoft has  benefited from digitization and the shift to working from home that was accelerated by the pandemic. Since 2017, revenue has grown by at least 10% every quarter and that has continued this year. Microsoft Teams, the company’s virtual collaboration tool, now has over 145 million daily active users around the world. This is up from just 32 million daily active users back in March of 2020. Microsoft management believes that the pandemic will forever change how people work and learn, and that their software and cloud services will enjoy improving fundamentals from this change in the long term. Azure cloud revenue has grown over 40% every quarter for well over three years now. As the second largest cloud player in the world, Microsoft’s scale in the Cloud industry will be hard for smaller competitors to replicate any time soon.

Philip Morris International, Inc. (PM)
Philip Morris is executing on their transition towards more smoke-free products. The success of their heated tobacco product IQOS has led their smoke-free portfolio to account for nearly 30% of total revenues.  Management expects that heat-not-burn products will account for about 40% of total revenue by 2023. Volumes for their IQOS device are growing in the double-digit percentages every quarter. Philip Morris is targeting a compound annual growth rate for EPS of 9% from 2021 through 2023. The company maintains a strong dividend with a yield that has remained above 4% since 2018 and they have increased the payout for 12 consecutive years. It ranks as one of the top performing stocks in the market since 1926.

Biogen, Inc. (BIIB)
Biogen stock had an incredible quarter and was up 24.24% due to the approval of their Alzheimer’s drug Aduhelm. This is the first new treatment approved for Alzheimer’s in nearly two decades. Alzheimer’s is the sixth leading cause of death in the US and affects more than 30 million people worldwide. Due to few treatment options for the disease, Biogen anticipates that Aduhelm will grow into a multibillion-dollar product over the next several years. Bernstein analysts estimate that Aduhelm could reach peak sales of $10 billion, which would lead to record levels of revenue for Biogen. Along with their work on Aduhelm, Biogen will continue to invest in other areas of need such as neurodegenerative diseases and retinal disorders. The company expects to invest $2.3 billion to $2.4 billion into research and development in 2021. Biogen is committed to returning capital to shareholders through share repurchases as they have $4 billion of authorized share repurchases remaining.

Alphabet, Inc. (GOOGL)
Alphabet continues to benefit from the strength of Google Search, which controls over 90% of the global online search market. There are over four billion internet users worldwide and Google is the dominating presence in the global online space. Alphabet owns Google.com and YouTube.com, the #1 and #2 most visited websites in the world. Google gathers large amounts of data from their users, enabling them to advertise more effectively than their competitors. Alphabet benefits from a network effect and as their userbase grows, more advertisers will be drawn to their services. They maintain a solid balance sheet with over $120 billion in cash, allowing them to continue to invest in new products and technologies such as their cloud service which is now a top five player globally. Alphabet is also actively investing in the areas of drone delivery, autonomous vehicles and quantum computing. The company is buying back $50 billion of their stock.

UnitedHealth Group, Inc. (UNH)
As the largest private health insurance provider in the US, UnitedHealth has proven to be resilient to uncertain market environments. The company also has a top three pharmacy benefits manager with OptumRx. UnitedHealth’s integrated strategy has led to consistent performance with revenue growing every quarter for over 20 years now, including during the 2008 financial crisis and the COVID-19 pandemic. The company’s scale and integration also create cost advantages that make it hard for smaller competitors to take substantial market share. Analysts call for earnings per share of $18.57 for 2021 and $21.37 for 2022. Management is targeting 13%-16% earnings growth for the long term. UnitedHealth recently announced their plan to acquire Change Healthcare for $13 billion, which would strengthen their digital health capabilities.

Detractors to the quarter:  Our outlook on a cross section of positions with a negative impact on the portfolio for the quarter ended 6/30/2021.

Discovery Communications, Inc. (DISCA)
Discovery has had dramatic moves in stock price this quarter, mainly due to a major blow up of the hedge fund Archegos and the announcement of a merger with AT&T’s WarnerMedia. The combined company, which should be finalized in a year, puts a current EBITDA multiple under 10x. Amazon just paid close to 40x for MGM. With lots of streaming competition, the market has been uncertain about how well Discovery and WarnerMedia will perform. However,  John Malone  is a major investor  with an excellent track record. We have held his companies for over 20 years. We expect further consolidation in streaming with the new Warner Bros. Discovery, an attractive candidate due to their global franchise.

Johnson & Johnson (JNJ)
Though Johnson & Johnson underperformed during the quarter, the company is seeing a boost to sales and earnings as virus-related restrictions are lifted. The second quarter saw record levels of both sales and earnings thanks in large part to previously deferred medical procedures being completed. Johnson & Johnson expects to produce up to 600 million doses of its COVID vaccine in 2021 though, unlike Pfizer and Moderna, they do not expect to make a profit on the sale of the vaccine. Management has increased their full-year guidance and now expects EPS of $9.60-$9.70 and base business sales growth of 10.5%-11.5%. Johnson & Johnson continues to invest heavily in their future growth with one of the top 10 largest pharmaceutical pipelines in the world. The company also has a solid history of returning capital to shareholders with 59 consecutive years of dividend growth.

Mastercard, Inc. (MA)
Concern over the Delta variant of COVID-19 spreading and hampering travel has been reflected in Mastercard’s performance this quarter. Cross-border transactions have suffered. However, unless lockdowns are reinstated, we don’t see Mastercard’s growth slowing down. They continue to be a duopoly with Visa, controlling the toll road of payments.  They are relentlessly focused on the future. Mastercard’s CEO was quoted saying, “If you wandered around the office and asked people, from the junior most employee, to the employee who has been here 35 years, ‘what do you think Mastercard’s mission is?’ they will say ‘killing cash.’ It’s embedded in everything that we’re doing. And it’s not mixed in with other things. Our mission is to kill cash.”

Abbott Laboratories (ABT)After having benefited from COVID testing this past year, Abbott Labs fell when it guided for lower earnings due to decreased demand in equipment. Abbott has a fortress  balance sheet and has  grown earnings at 17% annually over the last five years. Innovative products like the FreeStyle Libre blood glucose monitor franchise continue to drive growth.  Healthcare stocks in general have lagged this year  and we see many names that sell at the  cheapest valuation  versus the market in over 20 years, despite favorable demand demographics.

Corning Incorporated (GLW)
Corning pared back gains after having a nice 25% runup from the start of the year. Corning makes everything from the glass that is on iPhones, to pharmaceutical vials, to their largest business segment, which is focused on 5G specialized fiber, an area of strong future growth.  Their advanced fiber technology is only matched by one other competitor, YOFC, who charges more for a similar product.

In Closing

We strongly believe that investing is “the craft of the specific.” There has been such a proliferation of passive pools and ETFs that nobody truly knows what they own. The real advantage of following an active, rigorous research approach covering hundreds of individual companies and managements comes when we hit long  periods of flat to declining markets. In the 20th century, the Dow went up 180-fold. However, while the market rose for 43.75 years it was down for 56.25 years. During the period 1900-1921 the Dow rose from 66 to 71, less than 10% over 21 years. Between September 1929 and December 1948, the Dow declined from 381 to 180, over 50% in 19 years. For the years 1964-1981 the Dow gained one point from 874 to 875. More recently Tokyo’s Nikkei 225  plunged from a high of  38,915 at year-end 1989 to 7,862 by March of 2003. Being passive works great in raging bull markets, but in the flat-to-down periods returns are much more dependent on well-researched individual buys. Knowing intimately what you own, what to buy and  when to buy is where the years of cumulative knowledge become valuable.

We appreciate your trust.

Jeff Auxier

Before investing you should carefully consider the Fund’s investment objectives, risks, charges and expenses.  This and other information is in the prospectus, a copy of which may be obtained by calling (877) 328-9437 or visiting the Fund’s website.  Please read the prospectus carefully before you invest.

Fund returns (i) assume the reinvestment of all dividends and capital gain distributions and (ii) would have been lower during the period if certain fees and expenses had not been waived.  Performance shown is for the Fund’s Investor Class shares; returns for other share classes will vary.   Performance for Investor Class shares for periods prior to December 10, 2004 reflects performance of the applicable share class of Auxier Focus Fund, a series of Unified Series Trust (the “Predecessor Fund”).  Prior to January 3, 2003, the Predecessor Fund was a series of Ameriprime Funds.  The performance of the Fund’s Investor Class shares for the period prior to December 10, 2004 reflects the expenses of the Predecessor Fund. 

The Fund may invest in value and/or growth stocks. Investments in value stocks are subject to risk that their intrinsic value may never be realized and investments in growth stocks may be susceptible to rapid price swings, especially during periods of economic uncertainty. In addition, the Fund may invest in mid-sized companies which generally carry greater risk than is customarily associated with larger companies. Moreover, if the Fund’s portfolio is overweighted in a sector, any negative development affecting that sector will have a greater impact on the Fund than a fund that is not overweighted in that sector. An increase in interest rates typically causes a fall in the value of a debt security (Fixed-Income Securities Risk) with corresponding changes to the Fund’s value.

Fund holdings and sector allocations are subject to change and should not be considered a recommendation to buy or sell any security.

Foreside Fund Services, LLC, distributor.

The S&P 500 Index is a broad-based, unmanaged measurement of changes in stock market conditions based on 500 market-capitalization-weighted widely held common stocks. The Dow Jones Industrial Average is a price weighted index designed to represent the stock performance of large, well-known U.S. companies within the utilities industry. The S&P 500 Equal Weight Index (EWI) is the equal-weight version of the widely used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight (0.2%) of the index total at each quarterly rebalance.  The MSCI Emerging Market Index captures mid and large caps across more than two dozen emerging market countries. The index is a float-adjusted market capitalization index and represents 13% of global market capitalization. The 60/40 Hybrid of S&P 500 and Bloomberg Barclays U.S. Aggregate Bond Index is a blend of 60% S&P 500 Composite Index and 40% Barclays U.S. Aggregate Bond Index, as calculated by the adviser, and is not available for direct investment. The Bloomberg Barclays US Aggregate Bond Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States.  The Russell 1000 Value Index refers to a composite of large and mid-cap companies located in the United States that also exhibit a value probability. The Russell 1000 Growth Index measures the performance of the large cap growth segment of the US equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.  One cannot invest directly in an index or average.

EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a measure of a company’s overall financial performance and is used as an alternative to net income in some circumstances.

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock.

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care.

Return on invested capital (ROIC) is a calculation used to assess a company’s efficiency at allocating the capital under its control to profitable investments.

The views in this shareholder letter were those of the Fund Manager as of the letter’s publication date and may not reflect his views on the date this letter is first distributed or anytime thereafter.  These views are intended to assist readers in understanding the Fund’s investment methodology and do not constitute investment advice.

Auxier Report: Spring 2021

Mar 31, 2021

Download Auxier Report Spring 2021

Spring 2021 Market Commentary

During the first quarter of 2021, equity markets continued to rally on the back of strong earnings and powerful macro tailwinds. As COVID-19 vaccinations have been widely accessible, local restrictions have eased and demand is rebounding. Monetary and fiscal government accommodation  has continued to be aggressive.  Money supply growth is still running over 25%. The Fed continues to buy $120 billion in bonds per month for a total in excess of $2.4 trillion from February 2020. Since August of 2020, we have seen a material change in market leadership as cheaper, more cyclical businesses have been outperforming higher priced growth and momentum stocks. Smaller cheaper value stocks in the Fund have been among the best performers. The economic numbers are showing surging domestic demand while supply chain interruptions are leading to material price hikes across many industries. Personal income is hitting records (with over 30% from government payments). Semiconductor shortages are hampering production in numerous industries like autos and appliances. Intel CEO Pat Gelsinger believes semiconductor shortages could extend through 2021 into 2022. Most raw commodities prices are soaring this past year with lumber up over 300% and corn up 80%. Steel is up 60% just in 2021. Data from the Labor Department showed that 916,000 seasonally adjusted jobs were added  in March. This was the biggest gain since August and helped drive the unemployment rate down to 6%, the lowest since the beginning of the pandemic. US trucking companies are working to find more drivers as retailers and manufacturers rush to restock their inventory due to strong consumer demand. Knight-Swift Transportation Holdings has been hiring new drivers and their wages have recently increased by 40% or more.

Higher Rates Bad for Bonds, Great for Value Stocks

The first quarter saw a rapid increase in longer-term interest rates, leading to the worst  US government bond sell-off in more than 40 years. The 30-year Treasury lost 15.7%. At the end of the quarter, the yield on the 10-year Treasury note was 1.74%, up from 0.93% at year end. The US government is considering pumping another $1.9 trillion into the economy which could further boost growth and lead to even higher bond yields.  On a positive note, rising yields have been a  boost to the financial sector, cyclicals and many value-oriented businesses which are rebounding solidly in 2021. Many of our smaller companies that have been deeply undervalued and left for dead are now outperforming. The banks in general are benefiting from the pickup in gross domestic product (GDP), a steeper yield curve, the release of reserves, a resumption of stock buybacks and cheap valuations. The smaller banks are seeing a pickup in mergers and acquisitions.

Investments for a Higher Inflation Environment

The rapid recovery in the economy, along with severe supply chain disruptions, has led to strong pricing in most industries. As inflation rises there can be more downward pressure on highly valued momentum stocks. Over the past five years many of the most overpriced, money losing issues fared the best. This changes when inflation and interest rates rise. Price-to-earnings compression becomes a risk for money losing “high expectation” stocks with exciting stories but little value.  According to the Department of Labor, the Consumer Price Index (CPI) in March rose by 2.6% from a year ago, the highest year-over-year gain since August 2018.   Businesses that do well during inflationary periods  ideally  have high returns on invested capital, rapid inventory turns, low mandatory capital spending needs with strong franchises, reasonable valuations and the ability to raise prices. The power of  compounding is so phenomenal that a business with steady  high compounded rates of return  over long periods will crush inflation. Nearly half of the 2.6% year-over-year increase in the CPI in March was due to a 9.1% jump in gas prices. Energy prices as a whole ended the quarter up 13.2%, and up 77% over the last six months. In the past 12 months, overall food prices have grown 3.5%. However, take-out and delivery food services rose 6.5% which was the largest annual increase since the index began. In general, higher structural inflation occurs when countries adopt more socialist policies and where free market competition is stifled by government intervention leading to shortages. Venezuela and Argentina are two extreme, modern-day examples. So far, the belief by the Fed is that price pressures are transitory.

Managing Risks

One of the many risks we are seeing today is regulatory risk. Changes in regulation can have long lasting, material impacts on specific companies or entire sectors. Boeing is one company that faces regulatory risk, specifically surrounding their 737 MAX aircraft. After the plane was grounded in March of 2019, Boeing’s revenue and profitability fell as customers cancelled or delayed orders for the new plane. Though the FAA has since ungrounded the plane in November, other governing bodies like the US Transportation Department continue to keep a close eye on the company and could be the source of more headwinds in the future. Technology firms also face increased regulatory risks due to the rapid growth of digitization. The Chinese tech leader Alibaba continues to trade at a steep discount as Chinese regulators have been looking closely at the company’s competitive position over the last several months. While regulatory pressure for Alibaba has cooled off, there are still risks. The company’s largest shareholder, Jack Ma, has spoken out against the Chinese government’s control over its corporations leading to increased scrutiny. Alibaba’s investment in Ant Group is also facing regulatory headwinds which has led Fidelity to cut their valuation of the company down to $144 billion. Fidelity’s valuation of Ant Group reached $295 billion just last August prior to their IPO. Along with technology firms, the recent rise in popularity of cryptocurrency has led to concerns of potential regulatory action in the future. Bitcoin in particular faces increased risk  as governments around the world have started to outlaw it as a form of currency. Governments are reluctant to give up control over their currency.

Another risk we are watching is the current trend of excessive borrowing. Synthetic derivatives are a way for institutions to disguise extreme leverage. Recently, the investment firm Archegos was able to borrow over $30 billion against a $10 billion portfolio. The firm collapsed, leading to prime broker losses spread over several firms with aggregate losses totaling over $10 billion.  The rapid growth in small individual investors has also increased the borrowed money in the market. Ironically, “payment for order flow” (PFOF) which is how Robinhood charges no commissions was devised by convicted felon Bernie Madoff who committed one of the largest financial frauds in history. He paid discount brokers to access orders before they were routed to the market. The resulting poor execution is largely hidden from the public but can be very expensive. Apps like Robinhood make trading on margin incredibly easy and the app saw a substantial boost in trades during the quarter thanks to a massive short squeeze of GameStop stock and the growing popularity of cryptocurrencies. As of mid-February, FINRA reported that total margin debt stood at a record $813.68 billion. This was up 49% from the previous year and the fastest annual increase since 2007, before the financial crisis. Prior to that, the last time margin debt grew this quickly was during the 1999 dot-com bubble. This increase in borrowing has come from a shift in investors’ priorities, away from sustainable cash flow generation and earnings towards exciting stories largely based on momentum. In a momentum driven environment there is often an emphasis on “total addressable market” and revenue growth at any cost.  Currently, the market cap of companies that posted negative earnings last year and in the last three years is higher than during the dot-com bubble.

The rate of new initial public offerings (IPOs) is also nearing record levels. There were 457 IPOs in 2020 that raised a record $168 billion. Just through March 10 of this year, 310 IPOs have already raised $102 billion. At this rate, over $400 billion could be raised in 2021. During the 1999 bubble, there were 547 IPOs that raised $108 billion. Hot market environments like we are seeing now can cause many investors to be driven by emotions. Greed, envy and “group think” can be costly, especially when combined with borrowed money. Maintaining a rational temperament is vitally important to investment survival.

Rapid Market Recovery

Last year, the stock market experienced one of the sharpest declines in recent memory due to the COVID-19 pandemic, but in the year since it has also experienced one of the quickest recoveries. While the virus’s impact on the market was dramatic, it proved to be more of a temporary shock with a quick reversal due largely to the dramatic response by the Fed and  massive government stimulus. The following graphic shows the corrections from notable events in the US stock market over the last 150 years. The graphic also provides a pain index number which considers the severity of the decline and how long the market took to recover.

One thing that the pandemic highlighted is the importance of staying the course and  knowing market declines and panics are a normal occurrence. The S&P has dropped over 20% 26 times in 90 years according to Dow Jones Market Data. Instead of predicting markets, we focus on businesses and management teams that can endure the most challenging external shocks. Many investors panicked and sold their stock at the start of the pandemic due to uncertainties around how long a recovery would take, but in doing so they missed out on the quick recovery. Knowing what you own  through rigorous research and being current on the operating reality of each business helps you stay in the game during the height of panic and uncertainty.

First Quarter 2021 Performance Update

Auxier Focus Fund’s Investor Class returned 7.98% in the first quarter vs. 6.17% for the cap-weighted S&P 500 Index and 8.29% for the DJIA. The equal-weight S&P 500 returned 11.49%. Small stocks as measured by the Russell 2000 were up 12.70%.  The MSCI Emerging Markets Index gained 2.29%. A 60/40 S&P 500 and Bloomberg Barclays US Aggregate blended index returned 2.31% and bonds, as measured by The Bloomberg Barclays US Aggregate Bond Index, returned -3.37% for the quarter.

Stocks in the Fund comprised 98.4% of the portfolio. The equity breakdown was 87.2% domestic and 11.2% foreign, with 1.6% in cash and short-term debt instruments. A hypothetical $10,000 investment in the Fund since inception in July 1999 to March 31, 2021 is now worth $50,714 vs. $42,922 for the S&P 500. The equities in the Fund (entire portfolio, not share class specific) have had a cumulative return of 666.52% since inception and the Fund as a whole has had a cumulative return of 407.14% vs. 329.22% for the S&P. This was achieved with an average exposure to the market of  80.6% over the entire period.

Contributors to the quarter:  Our outlook on a cross section of positions with a positive impact on the portfolio for the quarter ended 3/31/2021.

Discovery, Inc. Series A (DISCA)
Discovery stock benefited during the first quarter from the launch of Discovery+ and the company’s new focus on digital direct-to-consumer content delivery. Since its debut in January, Discovery+ has already gained over 12 million paid subscribers thanks to its unique portfolio of unscripted content that enjoys worldwide recognition. Its main channel is one of the most widely distributed networks in the world and reaches more than 220 countries. Discovery is hoping to draw this large audience into Discovery+ to help offset continued declines in traditional TV subscriptions. Discovery has been working to expand their reach internationally to help diversify their revenue generation and protect against short-term disruptions. Currently, the company generates about 36% of its revenue from international markets. Management plans to continue investing into Discovery+ to scale up as they aim to shift their revenue mix towards their direct-to-consumer streaming products. Archegos Capital Management, through the use of synthetic derivatives called “total return swaps,” was able to apply up to five to one leverage against their portfolio. Their highly levered buying contributed to the huge gain for Discovery in the quarter,  but margin calls subsequently  led to forced liquidations of the stock. While Discovery has solid and improving fundamentals, the extreme hidden leverage of Archegos has contributed to extraordinary volatility. This shows the importance of knowing what you own, what it is worth and the impact of forced debt liquidations.

Bank of America Corp. (BAC)
Despite one of the most challenging economic environments in recent memory, Bank of America has been able to maintain positive earnings throughout the pandemic, highlighting the success of their transformation over the last decade. Management anticipates a continued recovery from the pandemic as the company recently decreased their provision for credit losses substantially. Digital banking continues to be a strong point for the company, making up nearly 50% of all consumer banking sales. Bank of America leverages their scale in the banking industry to benefit from cost savings and switching costs. In mid-March, the Fed increased its 2021 GDP growth forecast to 6.5%. Bank stocks tend to perform well as the economy strengthens. Investors have been eying increasing demand for loans and decreasing default rates which boost profit margins for companies like Bank of America.

Corning Inc. (GLW)
Despite substantial headwinds, Corning has been able to successfully navigate the pandemic environment. Earnings returned to positive territory after the first half of 2020 as Corning benefited from recoveries in the medical and technology industries. The company has shipped their Valor Glass vials to support more than 100 million COVID-19 vaccine doses. Corning’s toughest glass yet, Gorilla Glass Victus, is featured on some of the highest selling smartphones in the industry like the latest iPhones and Samsung devices. Corning has long been the go-to company for the best smartphone screen glass and Gorilla Glass Victus will help continue their leadership in the market. As a compliment to their contributions to the smartphone industry, Corning will also be a key player in the 5G market due to providing the optical fiber that network operators require. Optical Communications has been the company’s highest grossing segment and management is confident that this trend will continue as the digitization of the world accelerates. Corning uses its scale to stay competitive by investing over $1 billion per year in research and development.

Central Pacific Financial Corp. (CPF)
Central Pacific Financial, based in Hawaii, maintained consistent performance even in the face of a disruptive economic environment. The company’s most recent quarter saw revenue growth at its highest level since before the pandemic began. Management has attributed the company’s success to the completion of their RISE2020 initiative which aimed to increase their digital presence and revitalize their ATMs and physical locations. The company’s new online and mobile banking platforms have become popular ways for customers to meet their banking needs. Central Pacific has also been consolidating low-earning branches and their most recent consolidation is expected to bring annual expense savings of $1.8 million. Central Pacific has benefited from a relatively rapid recovery in the Hawaiian market as it has the 2nd lowest per capita COVID-19 case rate in the nation. The company’s loan portfolio is diversified with consumers making up 55% of loans and commercial making up 45%. Central Pacific has strong annual free cash flow generation of $50 million and maintains nearly $100 million in cash on their balance sheet.

Detractors to the quarter:  Our outlook on a cross section of positions with a negative impact on the portfolio for the quarter ended 3/31/2021.

PepsiCo, Inc. (PEP)
While known for their namesake soda, PepsiCo has a wide variety of offerings in the drink and snack markets including 23 brands with at least $1 billion in annual sales and is the second largest food company, behind Nestle, based on net revenue. With over half its revenue coming from the United States, PepsiCo had a tough macroeconomic environment with lockdowns for COVID-19. However, they still managed to increase core earnings in 2020 by 2% due in part to a 4.3% increase in core organic revenue. Earlier this year PepsiCo announced a 5% dividend increase to $4.30 per year effective June 2021. This marks the 49th consecutive year PepsiCo has increased their dividend.

Merck & Co., Inc. (MRK)
While their COVID-19 vaccine efforts were not fruitful, Merck still has Keytruda, the second largest drug in the world by revenue, and a stellar pipeline with 38 phase two programs, 22 phase three programs, and five programs under review. 70% of its pharma portfolio consists of physician-administered drugs, which has been hurt by reduced patient office visits. Merck ranks number two in the industry for R&D expenditures and, despite being a clear leader in the immuno-oncology market, sells for a very cheap 12 times earnings.

Visa Inc. (V)
Visa has suffered from weak cross border transactions as much of Europe is still in recession. It has been rolling out Visa Direct, which is growing twice as fast as when they rolled out their Debit platform in the ‘90s.  They are trying to be “the network of networks.”  For example, Visa and Airbnb just partnered to use Visa Direct in order to get hosts paid faster.  In March, The Wall Street Journal reported that the Justice Department is investigating Visa for anticompetitive practices with their debit card transactions. The DOJ’s Antitrust Division is attempting to determine whether Visa limited merchants’ ability to use other, less expensive networks. Also in March, Visa announced a partnership with Hong Kong-based Crypto.com. Crypto.com is an online payment and cryptocurrency platform that gives Visa some access to the burgeoning cryptocurrency market.

Medtronic PLC (MDT)
By 2030 all baby boomers will be 65 or older. By 2060, according to the US Census Bureau, the US population will grow by 79 million people to 404 million while the median age will go up five years to 43. Medtronic has a strong culture focused on innovation. It is the largest pure-play medical device maker. They hold 49,000 patents. In March, the FDA approved a new transcatheter pulmonary valve for patients with congenital heart disease. Congenital heart disease is the most common birth defect in the US, affecting an estimated 40,000 infants a year.

Outlook

The overall economic growth this year looks to be the strongest since 1983. Cost pressures and inflation have been making news as core inflation is running the highest in over a decade. During that strong economy back in 1983-84 I remember buying tax free municipal bonds paying 10%. Today they are closer to 1%, a negative real return. We are still able to selectively find high-return, quality businesses, large and small, that enjoy free cash flow  and earnings yields far in excess of the prevailing bond yields. While improved pricing is helpful for sales and earnings across many industries, higher, sustained  inflation can lead to a compression in overall stock values posing a greater risk to the most overpriced stocks and sectors in the market.  We are encouraged the past few months to see a return to investing fundamentals where price and value matter. The spread between the cheapest and most expensive stocks has been the widest in my career and we stand to benefit with a reversion to the mean. We are also seeing the fruits of our numerous management  research meetings over the past two years, especially in smaller businesses where many exceptional management teams have been largely ignored as money has flooded into exchange traded funds and passive products.

We appreciate your trust.

Jeff Auxier

Before investing you should carefully consider the Fund’s investment objectives, risks, charges and expenses.  This and other information is in the prospectus, a copy of which may be obtained by calling (877) 328-9437 or visiting the Fund’s website.  Please read the prospectus carefully before you invest.

Fund returns (i) assume the reinvestment of all dividends and capital gain distributions and (ii) would have been lower during the period if certain fees and expenses had not been waived.  Performance shown is for the Fund’s Investor Class shares; returns for other share classes will vary.   Performance for Investor Class shares for periods prior to December 10, 2004 reflects performance of the applicable share class of Auxier Focus Fund, a series of Unified Series Trust (the “Predecessor Fund”).  Prior to January 3, 2003, the Predecessor Fund was a series of Ameriprime Funds.  The performance of the Fund’s Investor Class shares for the period prior to December 10, 2004 reflects the expenses of the Predecessor Fund. 

The Fund may invest in value and/or growth stocks. Investments in value stocks are subject to risk that their intrinsic value may never be realized and investments in growth stocks may be susceptible to rapid price swings, especially during periods of economic uncertainty. In addition, the Fund may invest in mid-sized companies which generally carry greater risk than is customarily associated with larger companies. Moreover, if the Fund’s portfolio is overweighted in a sector, any negative development affecting that sector will have a greater impact on the Fund than a fund that is not overweighted in that sector. An increase in interest rates typically causes a fall in the value of a debt security (Fixed-Income Securities Risk) with corresponding changes to the Fund’s value.

Fund holdings and sector allocations are subject to change and should not be considered a recommendation to buy or sell any security.

Foreside Fund Services, LLC, distributor.

The S&P 500 Index is a broad-based, unmanaged measurement of changes in stock market conditions based on 500 market-capitalization-weighted widely held common stocks. The Dow Jones Industrial Average is a price weighted index designed to represent the stock performance of large, well-known U.S. companies within the utilities industry. The S&P 500 Equal Weight Index (EWI) is the equal-weight version of the widely used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight (0.2%) of the index total at each quarterly rebalance.  The Russell 2000 index is an index measuring the performance of approximately 2,000 smallest-cap American companies in the Russell 3000 Index, which is made up of 3,000 of the largest U.S. stocks. It is a market-cap weighted index. The MSCI Emerging Market Index captures mid and large caps across more than two dozen emerging market countries. The index is a float-adjusted market capitalization index and represents 13% of global market capitalization. The 60/40 Hybrid of S&P 500 and Bloomberg Barclays U.S. Aggregate Bond Index is a blend of 60% S&P 500 Composite Index and 40% Barclays U.S. Aggregate Bond Index, as calculated by the adviser, and is not available for direct investment. The Bloomberg Barclays US Aggregate Bond Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States.  One cannot invest directly in an index or average.

Cryptocurrency (notably bitcoin), often referred to as “virtual currency” or “digital currency”, operates as a decentralized peer-to-peer financial exchange and value storage that is used like money. Cryptocurrency operates without control authority or banks and is not backed by any government. Even indirectly, cryptocurrencies may experience very high volatility. Cryptocurrency is not a legal tender. Federal, state or foreign governments may restrict the use and exchange of cryptocurrency and regulation in the U.S. is still developing. Cryptocurrency exchanges may stop operating or shut down due to fraud, technical glitches, hackers, or malware.

Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a business.

An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance.

Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets.

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).

A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates.

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care.

Return on invested capital (ROIC) is a calculation used to assess a company’s efficiency at allocating the capital under its control to profitable investments.

The views in this shareholder letter were those of the Fund Manager as of the letter’s publication date and may not reflect his views on the date this letter is first distributed or anytime thereafter.  These views are intended to assist readers in understanding the Fund’s investment methodology and do not constitute investment advice.

 

Auxier Report: Winter 2020

Dec 31, 2020

Download Auxier Report Winter 2020

Winter 2020 Market Commentary

Global equity markets continued a powerful rally in the fourth quarter.  In the US, the S&P 500 returned 12.15%. The swift recovery is surprising, following the worst economic decline in a first quarter since the Great Depression. Remarkable advances have been made with vaccines to address the COVID-19 pandemic; two were recently approved by the Food and Drug Administration (FDA). Normally it takes several years to develop an effective vaccine. The pace of innovation has been astounding. In addition, the global  fiscal and monetary response has been the most aggressive in history—nearly triple that of prior downturns. US money supply has been growing over 25% annually, the highest in over 150 years.  According to the International Monetary Fund (IMF), governments and central banks globally have provided over $19 trillion in stimulus in 2020.  They forecast 5.5% global gross domestic product (GDP) growth. Bank of America predicts 6% US GDP growth in 2021. Despite these forecasts, over $15 trillion in bonds are still priced to yield negative returns. Inflation adjusted fixed income markets are very unattractive.  The purchasing power risk combined with the potential price declines in a rising rate environment makes the risk/reward in bonds poor. The US dollar tends to depreciate 3% to 4% a year on average.

In the last quarter we have seen an outperformance in many of the beaten down value, cyclical and small cap areas of the market. A stronger economy should lead to better pricing, higher inflation and higher interest rates. The banks were decimated by low interest rates and high loan loss reserves resulting from the pandemic in the first half of the year, but came back to life in the fourth quarter.

With low inventories and strong demand, prices and margins are improving across many industries. We are seeing strong fundamentals in insurance, natural resources, used cars, semitrucks, lumber, farm commodities, etc. Wage gains look likely into 2021 as fast-food employees have been striking and there have been serious efforts by workers to unionize at Amazon. There is a strong push to raise the federal minimum wage. Transportation costs have been increasing as the Baltic Dry Index is up 128% over last year. Since early December, the index increased by nearly 60%. In Europe, 40-foot container shipping rates rose from $2,150 in November to $16,500 in January.  Online shopping is the rage, but higher shipping costs and record returns are material headwinds.  We watch inflation trends carefully as higher inflation and interest rates can compress price/earnings ratios, increasing the threat of “torpedoes” in the portfolio. Highly valued, high expectation stocks and longer-term bonds can be especially vulnerable.

The Millennial generation is quickly becoming the most important focus for many businesses. As of 2019, the number of Millennials reached 72.1 million and finally overtook the Baby Boomer generation in the US. The housing market is primed to begin benefiting from Millennials, with 90% planning to buy someday. The oldest of the generation have recently turned 40. Research by Goldman Sachs found that the peak home-buying age for Millennials is now 45. According to Coldwell Banker, by the year 2030, Millennials will have inherited over $68 trillion from their parents. We believe this massive generation of wealth will only strengthen the housing market. Pew Research estimates that, due to immigration, the Millennial population will continue to grow, peaking in 2033.

The Digitization of Media

We have seen five years of rapid digitization compress in less than a year. The conversion to streaming in media has been a major disrupter.  Large players like Netflix and Disney dominate the streaming conversation, but one player we like that tends to be overlooked is Alphabet’s YouTube, which has over two billion monthly active users watching over a billion videos per day. As YouTube is a free, ad-supported platform it brings substantial traffic and is the world’s most visited website after Google.com. YouTube is also the second largest search engine in the world, processing more than three billion searches a month. According to Pew Research, 73% of US adults use YouTube. Around 50% of US adults pay for or use a Netflix account. YouTube’s reach is immense. According to the Wall Street Journal, YouTube reaches more 24-49 year-old users than all cable channels combined. While YouTube has had a positive impact on Alphabet’s earnings, it has also greatly benefited creators, with the number of channels earning six figures growing by 40% every year. Along with YouTube, we also have our eye on the potential growth opportunities that newcomer Discovery+ could bring to the streaming landscape. Discovery, Inc. has been facing headwinds due to cord cutting, and launching their own service could be the spark the company needs to reinvigorate their growth. We see Discovery’s focus on unscripted content as a unique offering when compared to the scripted content of other major streaming players which could allow Discovery+ to sit comfortably alongside existing services. With cord cutting only anticipated to accelerate in the future, we like companies like Alphabet and Discovery, Inc. that offer unique streaming products that drive engagement and capitalize on digital entertainment.

Vaccine Update

Developing and distributing an effective vaccine to COVID-19 is a top priority for pharmaceutical companies such as Pfizer, Moderna and Johnson & Johnson (JNJ). While the Pfizer and Moderna vaccines have been given emergency use authorization by the FDA, JNJ’s vaccine has not yet been approved. Even though JNJ’s vaccine is behind Pfizer’s and Moderna’s, it does present some clear advantages that could help it become the best vaccine option for many. JNJ’s vaccine only requires one dose compared to the two doses required for the Pfizer and Moderna vaccines. A one-dose vaccine will be much easier to distribute around the country in a reasonable amount of time compared to a two-dose vaccine which requires time to pass between each dose. Another significant benefit of JNJ’s vaccine is that it is expected to be stable at refrigerated temperatures of 35.6 to 46.4 degrees Fahrenheit. Pfizer’s vaccine has more challenging storage needs and must be kept at minus 94 degrees Fahrenheit. This means that JNJ’s vaccine will not require new infrastructure to store and transport the vaccine. JNJ estimates that they will be able to produce enough doses to vaccinate 100 million Americans by April. Quick and effective vaccines for COVID-19 are needed to help protect the most vulnerable populations, such as those living and working in nursing homes. Data from early December indicates that about 40% of COVID-19 deaths in the US have been in nursing homes. Since JNJ’s vaccine requires fewer doses and can be more easily transported and stored than other vaccines, they may be the best option to treat this vulnerable group. It is estimated these vaccines will need to be taken every year due to the changing mutations. In time, as genetic testing improves, drugs will be better targeted to cure diseases. Today a company called OneOme, co-founded by the Mayo Clinic, offers pharmacogenomic solutions combining genome mapping and precision medicine testing. By building genetic databases specific drugs can be administered, improving the odds for favorable outcomes.

UnitedHealth Group Shows Resilience

The fourth quarter marked the end of a year that demonstrated UnitedHealth’s resilience to uncertainties as they were able to grow consistently throughout the year. Revenue for the company has increased every quarter for well over 10 years now as UnitedHealth has been able to keep operating at a high level despite economic disruptions like the financial crisis and the COVID-19 pandemic. UnitedHealth ended the fiscal year with record revenue thanks to the strength of Optum, their information and technology-enabled health services segment. Management expects their cash flow generation will continue to grow and reach $20-$21 billion in 2021. UnitedHealth has paid a consistent dividend for the last decade and with a payout ratio of just 30% the company has the flexibility to continue returning capital to shareholders.

Property Casualty Insurance Seeing A Recovery

The fourth quarter marked an improvement during a tough year for insurance providers as high catastrophe losses and COVID-19 charges impacted profitability. According to Swiss Re, total insurance losses in 2020 were estimated to be $83 billion, making it the 5th costliest year since 1970. Notable catastrophe events during the quarter included the California wildfires, with losses estimated to be in the $7 billion to $13 billion range. The North Atlantic hurricane season saw 30 big storms lead to $20 billion in claims. Swiss Re’s loss estimates do not include claims related to COVID-19, so total losses could be higher, though many insurers have pandemic-related exclusions in their contracts. Insurance companies have been trading at a discount due to investors’ fears of the impact of the pandemic, but these exclusions mean that the pandemic has had less of an impact than many investors expected. Travelers, for example, saw their core income grow by 45% over the fourth quarter of 2020 thanks to lower catastrophe claims and an increase in market returns. Exclusions to COVID-related losses helped Travelers beat analyst estimates. The massive catastrophe losses during 2020 will be the driving force of higher pricing in 2021. Pricing in insurance renewals was favorable and is expected to remain positive into 2021. January 1st reinsurance renewals were reported in the 5%-7% range. The US has seen the largest increases, followed by Europe and Asia. Rising primary pricing, low interest rates and increased risk concerns around catastrophes and COVID-19 are driving renewal growth. Strong pricing and lower catastrophe losses compared to 2020 are expected to lead to better profitability going forward. We believe Berkshire Hathaway, Marsh & McLennan, Aon, AIG and Travelers will all benefit from this improved pricing as the worst economic pressures on top lines are likely in the past.

CVS Undervalued After Successful Turnaround

CVS Health Corp is the nation’s foremost integrated healthcare services provider. CVS finished 2020 at $68.30 with projected earnings of $7.45 per share and a $2.00 dividend. This gives them a price-to-earnings ratio of slightly over 9x with a dividend yield of 2.93%. New entries into the pharmacy market, such as PillPack from Amazon, have scared investors away despite CVS’s long history of success and institutional knowledge. Amazon’s approach has been more focused on mail order, not face-to-face, which is a strength of CVS. The same thing happened to grocers in 2017 when Amazon purchased Whole Foods, but over three years later grocers have yet to see much of an impact. Executing in highly competitive markets is often harder than anticipated. Meanwhile CVS is preparing for the future with more vertical integration from the Aetna acquisition. While they dramatically increased their debt with the move, they brought on their CEO-in-waiting, Karen Lynch, while moving into the insurance space. We owned Aetna prior to the acquisition and have been following Karen Lynch for years. She takes over on February 1st and is expected to continue to expand the insurance division of CVS. In the interim, CVS will continue to pay down debt with their tremendous free cash flow, which is expected to break $10 billion in 2020. While they suspended share buybacks to pay down their debt from the Aetna acquisition, they are expected to hit their goal of 3x debt-to-cash flow sometime this year and could return significant value to shareholders as soon as 2022. All of CVS’s performance takes place in the backdrop of the COVID-19 pandemic. In 2020, they were the #1 testing site in the United States and have been working closely with the US government to help facilitate the vaccination of hundreds of millions of Americans in 2021. Nearly 70% of Americans live within 5 miles of a CVS, while over 85% live within 10 miles. Access to healthcare today is a major issue and CVS is determined to improve that access. 10,000 Americans turn 65 every day and it looks like the Biden administration wants to increase both Medicare and Medicaid coverage. With their near ubiquity, as well as their institutional experience delivering vaccines, CVS is likely to play a significant role in the vaccine rollout, exposing millions of new customers to the value CVS can provide. While the headlines might not be as exciting as those of a company like Amazon, CVS has the potential to provide significant returns with the fundamentals to back it up.

Fourth Quarter 2020 Performance Update

Auxier Focus Fund’s Investor Class returned 11.99% in the fourth quarter vs. 12.15% for the cap-weighted S&P 500 Index and 10.73% for the DJIA. The equal-weight S&P 500 returned 18.46%.  Emerging markets as measured by the MSCI Emerging Markets Index were up 19.70%. A 60/40 S&P 500 and Bloomberg Barclays US Aggregate blended index returned 7.54% for the quarter. Stocks in the Fund comprised 97.8% of the portfolio. The equity breakdown was 86.1% domestic and 11.7% foreign, with 2.2% in cash and short-term debt instruments. A hypothetical $10,000 investment in the Fund since inception in July 1999 to December 31, 2020 is now worth $46,967 vs. $40,426 for the S&P 500 and $37,543 for the Russell 1000 Value Index. The equities in the Fund (entire portfolio, not share class specific) have had a cumulative return of 609.59% since inception and the Fund as a whole has had a cumulative return of 369.66% vs. 304.26% for the S&P. This was achieved with an average exposure to the market of 80.4% over the entire period.

Contributors to the quarter:  Our outlook on a cross section of positions with a positive impact on the portfolio for the quarter ended 12/31/2020.

 

Bank of America Corp. (BAC)
Bank of America’s performance continued to be below 2019 levels as revenues have been pressured by low interest rates and expenses have been elevated due to COVID-related costs. However, performance improved sequentially in the second half of 2020. One area that has benefited during the pandemic is Bank of America’s digital usage. The company has seen over 2.3 billion quarterly digital banking logins. Over 70% of checks are now deposited digitally on the Bank of America platform.  The company’s partnership payment service, Zelle, now has 12.2 million active users and their most recent data shows transfers are up 88%. Management will continue to invest in the digital side of their business as they believe many users will prefer digital banking even after the pandemic has passed. Bank of America holds the #1 position in the US deposit market, with 85% of deposit transactions being made digitally.

Discovery, Inc. Series A (DISCA)
Revenue growth for Discovery slowed in 2020 due to reductions in TV advertising and cord-cutting, but future growth looks promising with the launch of their new streaming service Discovery+. Advertising currently makes up 50% of the company’s revenue so management is hoping that the launch of Discovery+ will begin to shift their revenue mix. Discovery currently has over 800 million monthly viewers around the world and has the #1 TV portfolio based on hours watched in the US. Management is confident that their service will be a good supplement to larger players like Disney+ and Netflix since Discovery+ will be the only major streaming service focused solely on unscripted content. Discovery expects 2021 to have the highest expenses for the streaming service due to the need to acquire new users, but expenses will decrease as the service scales. Along with investing in their digital offerings, Discovery generated over $3 billion in free cash flow this past year for a 7% free cash flow yield.

CAE, Inc. (CAE)
CAE is the global leader in training for civil and defense aviation. It is a much lower risk way to play the eventual turn in travel.  Earlier in 2020, CAE suspended operations in over half their civil training facilities, however all previously suspended locations have now been re-opened. This provided a tremendous bargain price in their stock. Management stated that they are now seeing recoveries in training utilization, particularly in business aviation training. After the Boeing 737 problems, pilot training is emphasized to a much greater degree. Management is confident that they will be able to recover once global travel gets closer to pre-COVID levels. Over 60% of CAE’s business comes from recurring business and long-term agreements with many airlines and defense forces. The company’s total backlog currently stands at over $8 billion.

Citigroup, Inc. (C)
Citigroup is selling for less than 80% of tangible book value. As stock buybacks resume, they are in a position to add tremendous value. A stronger global economy should lead to a reduction and further releasing of reserves and higher rates will benefit the record low net interest margin. Consensus estimates for Citigroup’s 2021 and 2022 earnings per share are $6.44 and $8.03, respectively. At nine times earnings the stock trades at a 60% discount to the market.

Detractors to the quarter:  Our outlook on a cross section of positions with a negative impact on the portfolio for the quarter ended 12/31/2020.

Microsoft Corp. (MSFT)
One of the largest companies in the world by market capitalization, Microsoft has managed to continue to grow and thrive despite the pandemic. The stock returned over 40% in 2020 behind strong growth from their Office suite of products, cloud businesses and gaming. Their cloud computing service, Azure, grew 48% last quarter. The work-from-home movement helped increase demand for their products as it further accelerated the trend towards digitization. Microsoft has invested heavily in the gaming industry with their Xbox system and their recent acquisition of ZeniMax Media. The gaming industry is already larger than the film industry and the global sport sector combined and is projected to continue its explosive growth over the coming years. Despite their investments Microsoft is still flexible with cash, cash equivalents and short-term investments of nearly $138 billion as of their most recent quarter.

Kroger Co. (KR)
Kroger is incredibly cheap compared to its peers. While Kroger’s price-to-earnings ratio is under 10, Walmart is over 20 and Target is over 25. In addition, Kroger’s dividend yield is substantially higher at 2.3% compared to Walmart’s 1.5% and Target’s 1.5%. Kroger’s price is depressed despite a strong year as people shopped more due to stay-at-home orders. While many still view Kroger as a traditional brick-and-mortar grocer, they have been successfully digitizing their business and currently trail only Walmart in online grocery sales. They plan to open their first automated fulfillment center in early 2021. Kroger has also started ramping up their preparations for the rollout of the vaccines. As one of the leading distributers of the influenza vaccine, they have extensive experience and their 2,200 pharmacies and 220 clinics could prove vital in the effort to vaccinate hundreds of millions of Americans over the coming months.

Mastercard Inc. (MA)
While they are still below pre-COVID-19 expectations, Mastercard has continued to see purchases increase after the abrupt drop off in March. The hardest hit unit has been cross-border transactions which was down 36% last quarter. However, cross-border transactions are likely to rebound quickly once COVID-19 restrictions are lifted and business starts to return to normal. In the meantime, Mastercard has focused on returning value to shareholders while maintaining a flexible balance sheet. In the third quarter alone, they repurchased 6.5 million shares for $2.1 billion while still finishing the quarter with over $10 billion is cash and cash equivalents. Mastercard also announced a 10% dividend increase in December to $0.44 per share.

Merck & Co. (MRK)
Merck has the second largest research budget of the major pharmaceutical companies.  Oncology sales continue to grow over 26%. The company is refocusing on vaccines, hospital acute care, animal health and oncology. They are spinning off the biosimilars, woman’s health and legacy brands into a new company called Organon. Merck estimates that the pandemic has so far negatively impacted revenue by over $2 billion due to reduced access to health care providers and reduction in demand for some of their vaccines. Despite these headwinds, they are on track for full-year revenue growth and a robust oncology and virology pipeline. Merck trades at a very cheap 13 times earnings, almost a 40% discount to the overall market. I first bought Merck in 1983 during the personal computer IPO frenzy where more than 30 personal computer companies went public. Over 90% failed to survive, yet Merck with a heavy emphasis on R&D is still going strong.

In Closing

The recent speculation in markets is nothing new. Charles Mackay’s book Extraordinary Popular Delusions and the Madness of Crowds published in 1841 was one of the first investment books I read back in the early 1980s. Human behavior, especially in groups, can be crazy at times.  “Easy money” contributes to momentum that detaches from reality and underlying cash flows. We are always ready to take advantage of bargains that result from irrationality and forced liquidations resulting from excessive borrowed money. There is an old saying that “financial genius is leverage in an up market.” In declining markets leverage takes you out of the game fast. Back in 1999 internet mutual funds had doubled in a year and were out of business within three years. From 1995-2000 the Nasdaq climbed 456% but then crashed 80% to end up back where it started. Steep losses can really interrupt the compounding of returns. We see the same kind of downside in many story-stocks that have been riding momentum as the emphasis is on revenue growth to the exclusion of other value yardsticks.  High prices and group behavior tend to attract a constituency that is often devoid of rational thought and behavior. We never lose sight of the power of the compounded return over long periods and the necessity of a persistent research effort to mitigate risk. If you drop 50% you need to recover 100% to break even and if you drop 90% you need to gain 1000% to break even. Although securities markets in the US have been good the past several years, they can have periods of flat performance like 1999-2009. During that decade, the S&P 500 returned a cumulative -4.27% while the Auxier Focus Fund returned a cumulative 83.67%. We tend to add the most value in those kinds of difficult periods.

We appreciate your trust.

Jeff Auxier

 

Before investing you should carefully consider the Fund’s investment objectives, risks, charges and expenses.  This and other information is in the prospectus, a copy of which may be obtained by calling (877) 328-9437 or visiting the Fund’s website.  Please read the prospectus carefully before you invest.

Fund returns (i) assume the reinvestment of all dividends and capital gain distributions and (ii) would have been lower during the period if certain fees and expenses had not been waived.  Performance shown is for the Fund’s Investor Class shares; returns for other share classes will vary.   Performance for Investor Class shares for periods prior to December 10, 2004 reflects performance of the applicable share class of Auxier Focus Fund, a series of Unified Series Trust (the “Predecessor Fund”).  Prior to January 3, 2003, the Predecessor Fund was a series of Ameriprime Funds.  The performance of the Fund’s Investor Class shares for the period prior to December 10, 2004 reflects the expenses of the Predecessor Fund. 

The Fund may invest in value and/or growth stocks. Investments in value stocks are subject to risk that their intrinsic value may never be realized and investments in growth stocks may be susceptible to rapid price swings, especially during periods of economic uncertainty. In addition, the Fund may invest in mid-sized companies which generally carry greater risk than is customarily associated with larger companies. Moreover, if the Fund’s portfolio is overweighted in a sector, any negative development affecting that sector will have a greater impact on the Fund than a fund that is not overweighted in that sector. An increase in interest rates typically causes a fall in the value of a debt security (Fixed-Income Securities Risk) with corresponding changes to the Fund’s value.

Fund holdings and sector allocations are subject to change and should not be considered a recommendation to buy or sell any security.

Foreside Fund Services, LLC, distributor.

Earnings growth is not representative of the Fund’s future performance.

The S&P 500 Index is a broad-based, unmanaged measurement of changes in stock market conditions based on 500 market-capitalization-weighted widely held common stocks. The Dow Jones Industrial Average is a price weighted index designed to represent the stock performance of large, well-known U.S. companies within the utilities industry. The S&P 500 Equal Weight Index (EWI) is the equal-weight version of the widely used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight (0.2%) of the index total at each quarterly rebalance.  The MSCI Emerging Market Index captures mid and large caps across more than two dozen emerging market countries. The index is a float-adjusted market capitalization index and represents 13% of global market capitalization. The Russell 1000 Value Index refers to a composite of large and mid-cap companies located in the United States that also exhibit a value probability. The Russell 1000 Value is published and maintained by FTSE Russell. The 60/40 Hybrid of S&P 500 and Bloomberg Barclays U.S. Aggregate Bond Index is a blend of 60% S&P 500 Composite Index and 40% Barclays U.S. Aggregate Bond Index, as calculated by the adviser, and is not available for direct investment.  The Baltic Dry Index (BDI) is a shipping and trade index created by the London-based Baltic Exchange. It measures changes in the cost of transporting various raw materials, such as coal and steel. One cannot invest directly in an index or average.

Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a business.

An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance.

Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets.

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).

Free cash flow yield is a financial solvency ratio that compares the free cash flow per share a company is expected to earn against its market value per share. The ratio is calculated by taking the free cash flow per share divided by the current share price.

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock.

The dividend yield, expressed as a percentage, is a financial ratio (dividend/price) that shows how much a company pays out in dividends each year relative to its stock price

Book value is the value of a security or asset as entered in a company’s books.

Nasdaq:  The Nasdaq Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange.

The views in this shareholder letter were those of the Fund Manager as of the letter’s publication date and may not reflect his views on the date this letter is first distributed or anytime thereafter.  These views are intended to assist readers in understanding the Fund’s investment methodology and do not constitute investment advice.

Auxier Report: Fall 2020

Sep 30, 2020

Fall 2020 Market Commentary 

The unprecedented events of 2020 have led many companies and industries to have wildly varying performance in the market. The pandemic has created a clear digital divide. The essential businesses who have digitized aggressively and kept strong balance sheets have adapted and outperformed year to date. However, this past quarter, after meeting firsthand with many CEOs, we are starting to see undervalued businesses that are more cyclical in nature outperform for the first time in many years.  Smaller companies are starting to perform better as well.  We try to stay on the pulse of businesses to catch the turn up in fundamentals. Inventory levels are very low and will need to be rebuilt. Manufacturing numbers out of China and the US are the best in two years. In the US, housing and autos have a positive multiplier effect. Record low mortgage rates are fueling a refinance boom and strong housing numbers, especially in suburban markets. Cheap gas and diesel prices are contributing to surging sales of trucks and SUVs. Used car prices are up over 12% for the year. The stock market is excited about the total addressable market for electric vehicles, but there are still over 278 million cars on the road that operate on gasoline or diesel. Boat, RV and bike sales have all seen shortages as people spend more time outdoors. The transportation sector, outside of airlines, has been recovering. FedEx and UPS have been able to take advantage of an increase in e-commerce as more people migrate to online purchases. Because of this change in consumer behavior, FedEx and UPS have seen their stock grow over 70% and 45% respectively this quarter. Other strong performers during the quarter were smaller companies like FirstService Corporation, Celanese Corporation and Lincoln Educational Services, gaining 31%, 25% and 40% respectively. I met the FirstService chief financial officer in 2003. They were a very small property management firm with a ton of energy and integrity. It has been the best performing stock in the Fund since inception.  That is why we like companies that are family owned or founder run, because management tends to care more about the business and its reputation over the long term, not a quick-hit lottery ticket. On the downside, the energy, aerospace, travel and service sectors have been pummeled. In-person conferences and global travel have suffered. Goods have been outperforming services, especially where groups are involved. Spending on goods was up 6.7% versus spending on services, -7.7% for the quarter. Commercial real estate and the proliferation of collateralized mortgage obligations are suffering, forcing dramatically higher banking reserves. This and low net interest margins are hitting banks’ income statements hard.

Digital Ad Growth

We are seeing an accelerated move to digital ads due to COVID-19. Companies like Snap, Pinterest, Facebook, Alphabet, Alibaba and Amazon with advanced data analytics are transforming the industry. The Interactive Advertising Bureau (IAB) expects digital ad spending to increase by 6% in 2020 despite virus-related headwinds. The IAB also estimates that traditional media advertising will decline by 30% this year indicating that companies are prioritizing digital ads as many consumers are spending so much more time at home. Alphabet’s YouTube is enjoying digital ad growth greater than 31%.

Housing

The housing market has also been performing well amid the pandemic. According to Bankrate and Freddie Mac, the 30-year fixed-rate mortgage fell to an all-time low of 2.86%. Demographically, there are over 90 million millennials in the US which represents the potential for strong multiyear demand. The “work from anywhere” trend is helping people move out of cities into suburban, highly aesthetic and low-tax locations. The pandemic and remote technology have increased the demand for space and living areas with yards. The National Association of Realtors (NAR) found that completed housing transactions in September rose to 6.54 million on a seasonally adjusted annual rate, up 20.9% from September 2019. The highest in 15 years. Home remodeling has been strong with a surge in mortgage refinancing. A downside is the cost to maintain many of these houses and the potential for higher property taxes in areas where municipalities are enduring record revenue shortfalls.

Bubble Watch

With the suppression of interest rates the past few years, a momentum strategy rooted in  “growth at any price” has prevailed. Bubbles have historically started during periods of easy money and exciting technological developments. Eventually price levels get too far detached from cash flows, leading to crashes. Railroads in the 1830s, airplanes, cars and radios in the 1920s and the internet in the late 1990s are examples. Recently bitcoin and marijuana stocks soared the past few years then plummeted over 80%. Today, electric vehicles and enterprise software with IPOs like Snowflake priced over 100 times sales are experiencing excessive exuberance. This speculative activity can change overnight if inflation and interest rates were to reverse course. Over the long term, price and value are important despite generally being de-emphasized today. Overpriced momentum strategies tend to revert to the mean. The two big sins of investing I have witnessed over the decades that have consistently destroyed shareholder value have been CEOs overpaying in times of euphoria and adding more risk with borrowed money. There is a famous saying in the airline industry: “There are old pilots and bold pilots but no old, bold pilots.” Investing is similar. To endure over the long term it takes a committed, rational research effort to avoid permanent capital losses. Ego, emotion and “winging it” combine to blow up many portfolios and take investors out of the game. We have found humility and flexibility to be necessary character traits in order to survive the incredible competitive challenges that most businesses face. In the current environment, the focus of the market has been on revenue growth, almost to the exclusion of all other investment yardsticks.  Many losing companies have had tremendous returns based on exciting stories with little underlying cash flow. We have experienced these kinds of markets before. Disney, for example, was extremely popular in 1973 and the stock traded up to a price-earnings ratio of 81. Their revenue had grown 3.3 times over the prior seven years, yet in the 12 years from 1973 to 1985 the stock had a negative return despite sales growing five-fold. Popular, highly valued, “high expectation” stocks can torpedo a portfolio when they disappoint. Over the very long term it is difficult to maintain even a 13% growth rate. So high valuations tend to revert to the mean. Historically, index funds purchased at over 20-times earnings have had a negative return over the following ten years. Socialism is inflationary and inflation is the enemy of high price-to-earnings stocks. We continue to focus on doing deep dives into undervalued companies with strong or improving fundamentals that we believe have the potential to achieve “double-play” returns where improving fundamentals lead to expanding valuations.

COVID-19 Developments

Many companies are still feeling the impact of pandemic-related shutdowns while the race to find a treatment or vaccine for COVID-19 continues. Companies like Abbott Laboratories, Thermo Fisher Scientific, Quest and LabCorp are working to improve testing to help prevent future contact with the virus while others, like Pfizer, Merck and Johnson & Johnson, are working on vaccines. Merck may be best positioned to scale a vaccine, with decades of experience in mass producing vital vaccines. A recent study from the American Society of Hematology found that T-cells taken from the blood of recovered COVID-19 patients could be used to protect others from infection, as the cells maintain the ability to target the key proteins of the virus. T-cells are a critical part of the immune system that attack infected cells and pathogens.  The cures for cancer are coming through the immune system and CAR T-cell therapies are growing in importance not only in cancer, but in vaccines for viruses like the flu and COVID-19. We also see mineral deficiencies as a major contributor to many diseases. The cattle industry learned early on that in order to keep vet bills low, mineral supplementation was a necessity. Low vitamin D levels have been found in over 90% of COVID-19 deaths.  It appears that the best way to protect people is to focus on strategies and diets that will bolster individual immune systems. However, with cases rising in certain areas, some states and countries are weighing the possibility of additional COVID-19 lockdowns to help slow the spread of the virus, which could lengthen the recovery time for industries like energy, travel and entertainment. We continue to monitor these vulnerable industries closely during this time and remain focused on finding those select companies that have been able to find success.

Discounts on Managed Care Companies

Managed care companies like Anthem and UnitedHealth have historically seen discounts in election years as the healthcare industry is a common point of contention between candidates and uncertainty over the future of the industry is high. In the past four elections we have been a buyer of quality healthcare names that were bargains due to negative headlines. According to UBS, discounts relative to the S&P 500 peak around elections and then improve in the months afterwards as politics fade and the industry acclimates to any changes made. UBS has found that managed-care stocks have rallied 21% in the six months after the last 7 presidential elections. These stocks were up 44% a year after the last 7 elections, higher than the gains of the S&P 500. Post-election, companies like Anthem and UnitedHealth could see some positive tailwinds. The repeal of an Affordable Care Act tax on health plans in 2021 could save health insurers an estimated $15 billion annually. According to AARP, 10,000 people in the US turn 65 every day which would boost enrollment in Medicare plans. Election cycles provide unique opportunities to add strong, diversified companies that are trading at a discount relative to the market and have the potential to run.

Pandemic-Related Insurance Losses

An industry that could see a benefit from the pandemic would be the insurance industry. Pandemic-related claims have seen a spike and Lloyd’s estimates that total losses for the industry could reach $107 billion for 2020. This would be the largest loss on record for insurers due to a single event. The result of these losses is leading to a drop in capital levels and we are seeing prices on policy renewals spiking broadly. This improvement in pricing will greatly benefit insurers like Travelers, Chubb and Berkshire Hathaway. Insurance brokers like Aon and Marsh & McLennan should see an improvement as they thrive in what is known as a “hard market” for pricing.

Imminent Threat to Oil and Gas Overblown?

The global slowdown in air travel and the move to alternative energies have contributed to a supply glut in oil and fuel. Most oil stocks have dropped by over 50% this year. The shale industry is facing over $300 billion in asset write-downs. According to the Energy Information Administration (EIA), global consumption of oil reached 101.4 million barrels per day in 2019 and they currently expect consumption to fall by 8.6 million barrels per day for 2020. COVID-19 has greatly impacted transportation in the US, whether that be for entertainment or simply commuting to work. Transportation is a very important area for the industry as it was responsible for 68% of petroleum consumption in the US in 2019, according to data from the EIA. Shutdowns have changed how businesses operate, with many employees working remotely. Research from freelancing platform Upwork found that reduced commuting has saved Americans $90 billion since the start of the pandemic. While travel is still below pre-COVID-19 levels, it could slowly improve as shutdowns continue to be lifted. Increased e-commerce activity could help increase demand for oil from freight shipping and offset some of the lost demand from personal travel. Freight shipping has already seen a boost this year with online sales in the US growing 30.1% in the first 6 months of 2020 according to US Department of Commerce data. Deloitte is expecting holiday e-commerce sales to grow by 25%-35% for 2020 compared to growth of 14.7% in 2019. We continue to watch the industry carefully and, while the pandemic has greatly impacted global demand for oil and gas, we see a path to recovery as consumers begin to travel and commute to work again. Since gas powered vehicles make up most of the demand for oil, the rise of electric vehicles could threaten the oil and gas industry. Many auto manufacturers have begun to release plans to fully electrify their fleet in the future. Volkswagen has said that they will no longer develop gas or diesel-powered cars after 2026. Many countries have plans to ban sales of new gasoline cars by 2030-2040. Recently, California governor Gavin Newsom signed an order that would ban the sale of new gas cars and trucks by 2035. Other states could follow suit. Moves like these do present a possible threat to oil and gas demand but there are several factors which indicate that the world may not be ready yet for a transition away from traditional energy sources. Electric vehicles in California make up about 5% of the total fleet, more than any other state, and they are already facing rolling blackouts as energy supply cannot meet demand. To transition to fully electric by 2035, California will face challenges of even more blackouts. According to the EIA, natural gas was the largest source of US electricity in 2019 at 38%. Until renewable sources of energy become more widespread and consistent, the role of fossil fuels such as natural gas will continue to be vital, especially if the country is moving towards electric vehicles. As electric vehicles continue to grow, the demand for fossil fuels will need to increase to support the increase in electricity consumption. Even with the rapid growth of electric vehicles, they still represent an incredibly small portion of total vehicles on the road in the US. According to the Bureau of Transportation Statistics, there were over 1 million electric vehicles on the road in the US in 2018, representing less than 1% of total vehicles. Another positive for the industry is that low gas and diesel prices could increase demand for gas-powered vehicles as lower fuel costs are a big reason for consumers to switch to EVs. Renewed COVID-19 fears could keep the price of transportation fuels low until uncertainty subsides. Even if sales of gas-powered cars are eventually phased out, there will still be many on the road for years after that. Consumer Reports found that the average life expectancy of a new vehicle is around eight years, or 15 years for a well-built and well-maintained vehicle, which could lead to steady demand for oil and gas even years after gas-powered cars are phased out.

Long-Term Thinking a True Competitive Advantage

Staying in the market during volatile times is one of the hardest things for investors to do. Like Peter Lynch used to say, in the stock market “the key organ here isn’t the brain, it’s the stomach.” Over the longterm, markets tend to be resilient, but recency bias may lead many investors to sell low when stock prices go down or bad economic conditions arise. An internal study by Fidelity, which looked at their customers’ top returns between 2003 and 2013, showed that the best investors were either dead or had forgotten about their accounts. These types of accounts did not sell in uncertain times or downturns and instead allowed the power of compounding returns to work over the course of many years. Investors who panic and sell low can risk losing out on gains when the market rebounds. Below is a chart from Natixis Portfolio Research & Consulting Group showing the returns of the US stock market (S&P 500 TR) after the 10 worst months between 1985 and 2019.

Investors who sold after volatile times missed out on these market rebounds. Many investors do not have long-term time horizons and therefore could be missing out on gains from recoveries. Reuters analysis of New York Stock Exchange data showed that the average holding period for US stocks was just five and a half months in June. The average holding period has been falling for many decades. In 1999, the average was 14 months and in 1990 it was over 2 years. While long-term strategies may not be as widespread as they once were, we still believe holding stocks for the long term even through uncertain and volatile times provides the best opportunity to take advantage of potential rebounds.

 

Third Quarter 2020 Performance Update

Auxier Focus Fund’s Investor Class returned 5.64% in the third quarter vs. 8.93% for the cap-weighted S&P 500 Index and 8.22% for the DJIA. The equal-weight S&P 500 returned 6.75%. Small stocks as measured by the Russell 2000 were up 4.93%. Emerging markets as measured by the MSCI Emerging Markets Index were up 9.56%. Stocks in the Fund comprised 97% of the portfolio. The equity breakdown was 85.7% domestic and 11.3% foreign, with 3.0% in cash and short-term debt instruments. A hypothetical $10,000 investment in the Fund since inception in July 1999 to September 30, 2020 is now worth $41,938 vs. $36,047 for the S&P 500. The equities in the Fund (entire portfolio, not share class specific) have had a cumulative return of 601% since inception and the Fund as a whole has had a cumulative return of 319.37% vs. 260.47% for the S&P. This was achieved with an average exposure to the market of less than 80% over the entire period.

Contributors to the quarter:  Our outlook on a cross section of positions with a positive impact on the portfolio for the quarter ended 9/30/2020.

MasterCard Inc. (MA)
Cross-border volumes fell about 50% at the start of the pandemic and volumes have only slightly improved since then due to travel and entertainment spending remaining below 2019 levels. Cross-border volumes are important for Mastercard due to the higher fees they realize on these transactions. In other areas though Mastercard has seen some positive developments. Consumer spending in the US has begun to recover as the Commerce Department showed that spending increased 1.5% in July and 1% in August. Another positive development during the year is that due to concerns over hygiene and cleanliness, the use of contactless credit cards and mobile payments has increased. A study by Forrester Research found that 67% of retailers they surveyed accept contactless payment and since January, contactless payments have increased for 69% of retailers. Growth in digital payments means a continued shift away from cash which could benefit Mastercard in the long term.

Corning Inc. (GLW)
Though Corning’s business continues to be down compared to last year, the company has seen sequential growth in sales, earnings and free cash flow. Corning recently introduced their new Gorilla Glass Victus, which can survive higher drops and is twice as scratch-resistant as their previous version. Gorilla Glass is the most common glass used in smartphones. With the growth of 5G connectivity and wireless charging, the use of glass on smartphones is expected to become more widespread as glass casings do not interfere with 5G or wireless charging signals like metal casings do. As 5G connectivity becomes the standard, demand for Corning’s optical fiber could see a boost. For 5G technology to work and be consistent, a tighter mesh of radio antennas is needed compared to 3G or 4G connectivity which requires more fiber to be deployed. Higher demand for optical fiber could provide a boost to Corning’s biggest revenue generating segment. Management expects that the sequential improvement they have seen amid the pandemic will keep them on track to be cash flow positive for the full year.

FedEx Corporation (FDX)
FedEx has been able to take advantage of increased e-commerce activity in 2020 as people have spent more time shopping at home. During the quarter, FedEx reported pricing improvement in both its freight and ground shipping units. FedEx air freight has also been able to capitalize on less competition as commercial airlines have drastically cut flights. On the company’s most recent earnings call, management stated that the company is preparing for a peak like no other this holiday season as the pandemic continues to push more people to shop online. Before the pandemic, FedEx predicted the US would hit 100 million packages a day by 2026 and now they predict it will reach that number by 2023. FedEx could also benefit from a potential COVID-19 vaccine as the company manages 90 cold storage facilities and has experience in shipping temperature-sensitive products.

Medtronic plc (MDT)
During the quarter, Medtronic faced headwinds from the pandemic as patients continued to defer elective procedures, though management has seen sequential improvement as procedure volumes have begun to recover, especially in international markets. Even amid uncertainties surrounding the virus, Medtronic remains committed to returning at least 50% of their free cash flow to shareholders through dividends and repurchases. Medtronic has been incredibly consistent with their dividend and has increased the annual payment for 43 consecutive years. Medtronic continues to invest in new products to bolster their portfolio and this year they have already had over 130 regulatory approvals globally. Medtronic has been investing in a digital future with a focus on AI-driven surgical planning, robot-assisted surgeries and data analytics. Management believes their investment in these areas will lead to more effective surgeries and products as well as reduced costs.

United Parcel Service Inc. (UPS)
Like FedEx, UPS has seen a substantial increase in shipping volumes due to COVID-19 as people have been spending time at home. The company has seen a surge in residential shipments, healthcare-related shipments and strong demand from Asia. Holiday shopping, specifically online shopping, is expected to grow, which could help UPS reach record levels of revenue for 2020. Management is planning to hire 100,000 additional workers for the holiday season to help meet demand after already hiring 39,000 people in its second quarter. Through the pandemic, UPS has been able to maintain a steady balance sheet with increasing cash flow generation.

Abbott Laboratories (ABT)
Abbott Laboratories has been one of the most high-profile medical companies during 2020 thanks to their research on COVID-19 and their successful diagnostic tests. Abbott has released six different tests for COVID-19; four identify active infections and two are intended to identify past infection. Abbott has now sold over 40 million tests worldwide. The company has announced a new test called BinaxNOW which promises to deliver results in 15 minutes for as little as $5 per test. This test requires no special lab equipment, and its low cost could prove vital to widespread global testing as typical lab tests require special hardware and could cost over $100 per test. Aside from the strong performance of the diagnostics business, the rest of Abbott’s segments continue to be impacted by deferred procedures. Even with sales contracting due to the coronavirus, Abbott remains profitable with positive cash flow generation which should help the company remain flexible until the market stabilizes.

Detractors to the quarter:  Our outlook on a cross section of positions with a negative impact on the portfolio for the quarter ended 9/30/2020.

Bank of New York Mellon Corp. (BK)
Bank of New York Mellon has been hurt by the Fed’s zero rate policies which compresses their net interest margin. With $35 trillion in assets the bank will do much better as the economy recovers and interest rates rise. It sells at one of the lowest valuations in over twenty years.

CVS Health Corp. (CVS)
COVID-19 has led to lower than expected revenues for CVS as they had fewer new therapy prescriptions due to a drop in physical meetings. However, earnings were up over 50%, primarily due to reduced costs from deferrals of elective procedures and other discretionary utilizations in the Health Care Benefits Segment. While COVID-19 has led to a lot of disruption in the industry, CEO Larry Merlo is using this disruption to accelerate their transformation into a much more integrated healthcare company. He said they are excited about the opportunity to demonstrate “the ability to deliver care to consumers in the community, in the home and in the palm of their hand.” In the first six months of the year, CVS had over $10 billion in cash from operations, up over 40% year-over-year. CVS is also incredibly cheap, trading at under eight times earnings with free cash flow in excess of $9 billion.

Cigna Corp. (CI)
Fears of increased regulation and negative political headlines have hurt all health insurers and Cigna is especially cheap. The stock trades at a very low valuation with double-digit sales and earnings growth and a single digit P/E ratio. From 2014-2019 Cigna’s earnings compounded over 16% and the company generates free cash flow in excess of $9 billion annually. That is a free cash flow yield in excess of 13%. Cigna expects earnings to reach $20-$21 per share by 2021. The company maintains a 97% customer retention rate and management expects 10%-15% customer growth over the next 5 years.

Kroger Co. (KR)
Kroger has been a major beneficiary of the pandemic as more people continue to cook and eat at home. In their most recent quarter, Kroger reported sales ex-fuel grew 13.9% year-over-year and repeated 2020 EPS guidance of $3.20-$3.30. Their only headwind has been fuel, which has been hurt by low prices for oil and a decrease in demand as people have cut back on driving. Despite the positive trends through the year, Kroger stock is still cheap, trading at around a 10 times P/E ratio. Management has invested heavily in digital sales which doubled in the quarter. In September, Kroger’s board authorized a $1 billion share repurchase program.

Microsoft Corp. (MSFT)
Microsoft hit all-time highs in August before a market correction in tech took hold in September. While it slightly trailed the market in the third quarter, Microsoft has thrived through the work-from-home movement brought on by COVID-19 and has maintained consistent revenue and earnings growth through the pandemic. Daily active users on their Teams collaboration software has more than tripled since the beginning of the year. Quarterly revenue growth for their Azure cloud has remained over 40% due to strong demand as more businesses transition to digital operations. It has invested heavily in gaming with its Xbox systems as well as more recent investments in cloud gaming with xCloud. At the end of September, Microsoft agreed to purchase ZeniMax Media, parent company of Bethesda Softworks, for $7.5 billion. Gaming is one of the fastest growing forms of entertainment and is expected to reach nearly $160 billion in 2020 according to Reuters. In addition, the Microsoft Office product line has seen strong demand this year as more businesses and schools switch to remote work. Microsoft has over $136 billion in cash, equivalents and short-term investments.

The Travelers Companies (TRV)
While the net effects of COVID-19 on The Travelers Companies have been modest, they have had significant setbacks from higher-than-expected catastrophe losses. Hurricane Laura alone caused between $8-$12 billion in wind and storm surge losses in Louisiana and Texas. As large storms and fires become more frequent, catastrophe losses will go up. While this is tough on Travelers’ bottom line in the short term, the price increases on policy renewals   are broad and significant. Travelers has been in business for over 165 years and has been one of the most disciplined underwriters over the past decade. The stock is historically very cheap on a P/E and price-to-book.

In Closing

We believe the potential for government-driven shutdowns in response to the COVID-19 pandemic are far riskier than the virus itself. The lockdowns are a wildcard and disproportionately hurt the poor and schoolchildren. It creates a “winner-take-all” environment where technology driven platform companies grow even stronger. Another risk we monitor is the move to extreme statism and socialism. That can lead to a downward revaluation of financial assets as higher inflation leads to P/E compression. After dozens of meetings with CEOs in numerous industries over the past three months we are finally seeing fundamentals turning positive for many of the businesses we own. We are astounded at the pace of private sector innovation in healthcare and are optimistic that the COVID related problems will be resolved over the next several months.

We appreciate your trust.

Jeff Auxier

Before investing you should carefully consider the Fund’s investment objectives, risks, charges and expenses.  This and other information is in the prospectus, a copy of which may be obtained by calling (877) 328-9437 or visiting the Fund’s website.  Please read the prospectus carefully before you invest.

Fund returns (i) assume the reinvestment of all dividends and capital gain distributions and (ii) would have been lower during the period if certain fees and expenses had not been waived.  Performance shown is for the Fund’s Investor Class shares; returns for other share classes will vary.   Performance for Investor Class shares for periods prior to December 10, 2004 reflects performance of the applicable share class of Auxier Focus Fund, a series of Unified Series Trust (the “Predecessor Fund”).  Prior to January 3, 2003, the Predecessor Fund was a series of Ameriprime Funds.  The performance of the Fund’s Investor Class shares for the period prior to December 10, 2004 reflects the expenses of the Predecessor Fund. 

The Fund may invest in value and/or growth stocks. Investments in value stocks are subject to risk that their intrinsic value may never be realized and investments in growth stocks may be susceptible to rapid price swings, especially during periods of economic uncertainty. In addition, the Fund may invest in mid-sized companies which generally carry greater risk than is customarily associated with larger companies. Moreover, if the Fund’s portfolio is overweighted in a sector, any negative development affecting that sector will have a greater impact on the Fund than a fund that is not overweighted in that sector. An increase in interest rates typically causes a fall in the value of a debt security (Fixed-Income Securities Risk) with corresponding changes to the Fund’s value.

Fund holdings and sector allocations are subject to change and should not be considered a recommendation to buy or sell any security.

Foreside Fund Services, LLC, distributor.

Earnings growth is not representative of the Fund’s future performance. 

The S&P 500 Index is a broad-based, unmanaged measurement of changes in stock market conditions based on 500 market-capitalization-weighted widely held common stocks. The Dow Jones Industrial Average is a price weighted index designed to represent the stock performance of large, well-known U.S. companies within the utilities industry. The S&P 500 Equal Weight Index (EWI) is the equal-weight version of the widely used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight (0.2%) of the index total at each quarterly rebalance.  The Russell 2000 index is an index measuring the performance of approximately 2,000 smallest-cap American companies in the Russell 3000 Index, which is made up of 3,000 of the largest U.S. stocks. It is a market-cap weighted index. The MSCI Emerging Market Index captures mid and large caps across more than two dozen emerging market countries. The index is a float-adjusted market capitalization index and represents 13% of global market capitalization. One cannot invest directly in an index or average.

Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a business.

An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance.

Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets.

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).

Free cash flow yield is a financial solvency ratio that compares the free cash flow per share a company is expected to earn against its market value per share. The ratio is calculated by taking the free cash flow per share divided by the current share price.

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock.

The price-to-book ratio (P/B ratio) is used to compare a firm’s market capitalization to its book value. It’s calculated by dividing the company’s stock price per share by its book value per share (BVPS)

The views in this shareholder letter were those of the Fund Manager as of the letter’s publication date and may not reflect his views on the date this letter is first distributed or anytime thereafter.  These views are intended to assist readers in understanding the Fund’s investment methodology and do not constitute investment advice.

 

 

 

Auxier Report: Summer 2020

Jun 30, 2020

Download Auxier Report Summer 2020

Summer 2020 Market Commentary

During the second quarter digital business ushered in new innovations and we saw an increased focus on technology due to COVID-19. Companies that used technology to adapt their business models during this time have been able to shield themselves from pandemic-related disruption. While computers and other technologies have been rapidly evolving over the years, the lithium-ion battery was created in 1985 and is still the battery that we use today. Many companies are working on developing new types of batteries and energy storage solutions that will support the growing use of digitally connected devices like computers, phones and vehicles. IBM is researching a new battery chemistry that relies on materials extracted from seawater which could outperform lithium-ion batteries. Fisker Automotive is developing a solid-state battery for electric vehicles that could enable a range of 500 miles and a charging time of just one minute. Samsung just released their own 500-mile battery, although it is not yet commercially available. With the growth of digital businesses, we have seen small teams disrupting entire industries. These companies operate capital light business models by utilizing cloud software and artificial intelligence (AI) to scale more rapidly than large businesses that rely on a massive workforce and years of physical infrastructure. We look for businesses that are using mobile, the cloud, AI and data analytics at the core of their operations because these will only become more vital as the number of connected devices grows.

Recognize Investment Cycles

Easy money and industry deregulation often contribute to great booms and busts. The telecom deregulation in the late 1990s and aggressive Fed easing combined to cause massive oversupply leading to a severe   downturn. Blue chip telecom leader Lucent dropped over 98%. Soon after the telecom deregulation, the US banking industry was deregulated with the repeal of the Glass-Steagall Act.  Eventually, leverage ratios went to extremes—often 100:1—which contributed to the banking crisis and recession in 2008. More recently, relaxed lending standards in the oil shale industry led to a major boom  and now bust  with  $300 billion in projected asset write-downs in 2020, according to Deloitte. Understanding and tracking investment cycles is important to survival. We believe we are getting late in the current tech cycle given extreme valuations in many money losing enterprises. Euphoric pricing is the enemy of the compounded return. As great as Microsoft has performed recently, if you invested at the peak of excitement during the tech boom of 1999 you lost over 45% the following ten years.

Homework Needs to be Done Before the Crisis

We have found over the past forty years that a voracious daily research effort is the key to investment survival. You need to know what you own and what you want to own ahead of time to take advantage of opportunities presented by  recessions, stock market panics, wars, etc., when the headlines turn scary  and the consensus is “this is no time to be investing in stocks.” We strive to know which businesses are executing and where operating fundamentals are strong or turning up. The Carlos Slim family made their big returns buying into Mexican stocks when the country defaulted in 1982. This was after three generations of study. The top five oil families in Texas made it on the buy side as well when oil dropped to three cents a barrel in the 1930s. In both cases the families had years of diligent homework and cumulative knowledge of individual businesses and acted when the price was right.

COVID-19 Update

Even as daily new COVID-19 cases in the US continue to reach all-time highs, the average deaths per day from the virus have not increased at the same rate. This could be due to the greatly increased level of testing. As testing has increased, more mild cases of the virus have been found which has driven the death rate down. This could also indicate that the country has made positive progress on keeping the most vulnerable people isolated and that less vulnerable people have begun making up a larger portion of new cases.  While we still do not know the long-term impacts of the virus, the decline in death rate is a positive sign as the country works to contain this pandemic.

The Danger in Government-Mandated Shutdowns

Each year over 750,000 people die from the flu globally, yet there is little tracking by the media or mandated shutdowns for this deadly result.  The disruption in food chains by government-forced shutdowns could lead 265 million people worldwide into starvation by year end 2020, according to the World Health Organization. In 1932-33 the Soviet Union’s socialist leader Joseph Stalin collectivized farms and diverted key grain production from the Ukraine to Moscow, resulting in the starvation death of over three million Ukrainians in one year! This was a man-made famine which affected the major grain-producing areas of the country. This followed 1918 election propaganda of socialist “utopia”, free health care, free education, etc. Socialism sounds enticing to the masses but has a 100% failure rate with untold cases of human misery and suffering since 1918. Modern day Venezuela, once Latin America’s richest nation, now faces hyperinflation, chronic shortages, and corruption. It is estimated that one third of the population, or 9.3 million people, do not have enough food to eat. Another man-made government disaster.

Spending Stays Home

Stay-at-home orders have changed travel and entertainment habits for many people. In April, the TSA reported a 96% drop in international air travel as the pandemic forced the borders of many countries to close. The fall in global travel could bring opportunities for growth in domestic travel as people look for summer destinations in the US. In May, a survey of more than 14,000 US and Canadian travelers found that 57% of those surveyed said that if they were to travel in 2020 it would be domestically, with 43% saying they would be interested in traveling by road. Our channel checks show robust sales  in RVs, boats, bikes, camping supplies and off-road vehicles. RV sales have increased 170% compared to last year as people look for alternative ways to travel instead of flying. A “nesting” trend has stimulated sales for home offices, pools, computer games, garden supplies and pets.

Many non-essential businesses are suffering the effects of stay-at-home orders as demand fell dramatically during the second quarter. During the first half of the year Chapter 11 bankruptcy filings grew by 26% with a total of 3,604 businesses filing for the protection. Commercial Chapter 11 filings in June were up 43% over last year, bringing filings near 2008 recession levels.

Unusual times like these strengthen our focus on businesses with strong balance sheets and ample cash over pure growth stories. After the second quarter 43% of the Russell 2000 was losing money, yet largely due to the surge in government stimulus and money printing, lower quality money losers outperformed profitable companies by over 32%. Globally, over $18 trillion was pumped into the markets following the sharpest first quarter decline since the 1930s. Although the digitization of the economy has been a powerful theme, many of the stocks in the technology space are trading on euphoria and pure momentum.  The current Fed stimulus is more than three times that which preceded the internet bubble in 1999. In addition, in an unprecedented move the Fed has started buying individual companies’ bonds. This is a big factor in the rising prices.  A reversion to the mean could be painful for those speculating in exciting stories with little cash flow support. Sometimes it is easy to get swept up by these rapid growth stories, but it is always important to look past the stories and find the most financially sound businesses.

Acceleration of Digital Trends

Though COVID-19 forced many businesses to close their physical locations, the rate of digitization has dramatically accelerated. Many companies have had to quickly transition to utilizing digital collaboration tools to support most of their employees working from home. Apps from companies like Microsoft and Alphabet have seen substantial growth in users and meeting minutes because of the coronavirus. Microsoft’s Skype saw daily users increase 70% to 40 million at the start of the shutdown and their Teams app has reached over 75 million daily active users. Growth in collaboration apps like Skype and Teams could also benefit Microsoft’s other products like their Office suite. Businesses will be able to fully integrate other Microsoft apps like Word, Excel and PowerPoint into their digital meetings, creating a more seamless and effective work environment. Google Meet has been adding about three million new users each day and has seen a thirty-fold increase in usage since January. If companies can find success with a large portion of their employees working from home, then the increase in digital collaboration usage could become the norm going forward. Another area of digitization that has benefited from the current economic environment is the cloud. Cloud revenues for the major players, Amazon, Microsoft and Alphabet, have remained essentially unaffected by the pandemic. According to the Wall Street Journal, companies spent $34.6 billion on cloud services in the second quarter up 30% from the prior year. The public Infrastructure as a Service (IaaS) and Platform as a Service (PaaS) segments performed the best as businesses have moved more functions like databases and software to the cloud to better facilitate remote work. Another area where COVID-19 has made the need for digitization more apparent than ever is in physical retail, as stay-at-home orders have taken a toll on many businesses that were not prepared for disruption at this scale. Coresight Research has recorded a total of 4,005 announced closures by US retailers so far in 2020, and they estimate that retailers could announce between 20,000 and 25,000 closures this year due to the coronavirus, a record for the industry. These store closures could benefit some businesses as they will be able to reevaluate their footprint and downsize to a more sustainable level. In 2019 there were 8.5 billion square feet of retail space in the US which equates to about 24.5 square feet of space per person, over five times Europe’s average of 4.5 square feet per person. This overcapacity has crippled big retailers like Macy’s and JCPenney and a shift must take place for the industry to survive in a digital age.  By reducing their physical footprint and building out their e-commerce capabilities, physical retailers could become more resilient to future disruptions while also improving profitability. Rapid shifts in the market like what we have seen with COVID-19 emphasize the need to find companies on the right side of digital that will be able to succeed in a digitally focused economy. Things like working remotely and increased online shopping activity could become the norm once the dust settles and it is important to know which companies will be ready for that new environment.

Blockchain a Potential Disruptor

As the world becomes more reliant on the internet and digital business, the topic of data security has become more important than ever. Blockchain technology was originally created to securely manage transactions of digital currency but there are many more potential uses for the technology that could change the way people and businesses interact on the internet. One of the biggest advantages of storing data in a blockchain is that the data is secure, nearly impossible to alter and it can be verified by anyone in the world without having to rely on a third party for ensuring its authenticity. Blockchain is a public ledger of all transactions executed in a particular market that works by placing data into blocks with a unique identifying number; these blocks are then linked to the blocks before and after them, creating a chain. Thousands or millions of computers can then independently check and verify that this data is correct and then add the block to their ledger. These blocks all remain in the exact order they were placed into the network so that any data can be quickly and easily traced to its origin and verified. This creates a safe data environment that makes it effectively impossible for someone to alter or steal data in the blocks, because any change to a previous block of data will change every block that follows it. So, an attacker would have to change every block in the blockchain on more than 50% of every single computer in the network for their change to go unnoticed. Blockchains automatically update every 10 minutes, so an attacker would have to do this in that timeframe which would be nearly impossible. Because of this security, companies are looking at using the technology for many different applications that could disrupt existing online cloud solutions. The medical industry could use blockchain technology for safe recordkeeping. Patient data could be stored on the blockchain which could then only be accessed by authorized medical professionals. Ranchers in Wyoming are using blockchain with radio frequency identification (RFID) to track animals while greatly improving transparency. Other applications in the food industry include using blockchain to accurately track where products were produced and where they have traveled. Walmart and IBM have been using this technology and have been able to reduce the time for tracking certain food products from seven days down to 2.2 seconds. This can be vitally important as the World Health Organization estimates that 600 million people get sick from contaminated food every year. The future of blockchain technology is unknown but it has the potential to disrupt many industries including the massive cloud infrastructure industry. Cloud providers like Microsoft host their services on centralized servers which can face outages and outside attacks. Decentralizing the cloud could help lower the chances of these risks. One problem that blockchain technology currently faces is that its decentralized nature means that it is much slower and more expensive to operate than traditional cloud services. Even though blockchain offers increased reliability and security, consumers may choose to stay with traditional cloud providers to take advantage of lower operating costs and faster service. Blockchain technology is still in its early days and even with its current limitations it has the potential to one day disrupt many industries, so it will be important to see how the technology evolves and improves over the coming years.

Potential for Biotech and Medtech

Microsoft founder Bill Gates is predicting that more people will die from pandemics in the next thirty years than in wars. As a result, we have increased our research in biologics, specialty pharma, genomics and other areas of medical technology. We own many companies that are working on therapeutics and vaccines being developed to fight COVID-19. We see the focus on the immune system as a critical factor in not only the battle against cancer but also current and future pandemics. The exponential growth in critical data should accelerate cures for many debilitating diseases. We see this as an exciting investment opportunity for years to come.

Second Quarter 2020 Performance Update

Auxier Focus Fund’s Investor Class returned 13.59% in the second quarter vs. 20.54% for the cap-weighted S&P 500 Index and 18.51% for the DJIA. The equal-weight S&P 500 returned 21.73%. Small stocks as measured by the Russell 2000 were up 25.42%. Emerging markets as measured by the MSCI Emerging Markets Index were up 18.08%. Stocks in the Fund comprised 95.3% of the portfolio. The equity breakdown was 83.9% domestic and 11.3% foreign, with 4.8% in cash and short-term debt instruments. A hypothetical $10,000 investment in the Fund since inception in July 1999 to June 30, 2020 is now worth $39,699 vs. $33,092 for the S&P 500. The equities in the Fund (entire portfolio, not share class specific) have had a cumulative return of 564.19% since inception and the Fund as a whole has had a cumulative return of 296.98% vs. 230.92% for the S&P. This was achieved with an average exposure to the market of less than 80% over the entire period.

Contributors to the quarter:  Our outlook on a cross section of positions with a positive impact on the portfolio for the quarter ended 6/30/2020.

Microsoft (MSFT)
During the quarter, Microsoft’s cloud and digital collaboration tools helped the company grow during uncertain times. Stay-at-home orders forced many companies to rethink how they do business as they begin to look for ways to digitize their operations more rapidly. Azure cloud continued to drive growth for Microsoft and its revenue has grown over 45% in each of the last 4 quarters. The shift to working remotely has significantly boosted collaboration apps like Teams and Skype. COVID-19 has also had a positive impact on the gaming industry in which Microsoft has an interest with their Xbox brand. Play time on Xbox’s subscription service increased by 130% during the peak of the shutdown and the Xbox ecosystem now has nearly 90 million monthly active users. As a software focused company, Microsoft should be able to capitalize on the continued shift to digital following the disruption caused by COVID-19.

Mastercard (MA)
Even though stay-at-home orders have drastically reduced spending in areas such as travel and entertainment, Mastercard was still able to find success during the quarter. As more people were forced to stay home, spending in areas such as grocery, gaming and home improvement slightly offset the decrease in spending in travel and entertainment. According to JP Morgan Chase, total spending from customers fell 40% during the height of the stay-at-home orders in April compared to last year. While Mastercard could face some near-term headwinds due to a drastic drop in air travel and entertainment spending, management is confident that they will return to a position of strength once the economy begins to recover and the use of digital currency grows.

Lowe’s Companies Inc. (LOW)
Lowe’s has performed well as spending on home improvement has seen a boost during the pandemic. Home improvement spending grew 16.4% in May. E-commerce sales for the company grew by 80% as people took on more do-it-yourself (DIY) projects while staying at home. As many other companies temporarily laid off workers, Lowe’s has been able to continue hiring and recently announced another $100 million in bonuses for their hourly employees in the US. Home improvement retailers like Lowe’s can defend against the digitization of retail due to many large products being too expensive for online retailers to ship. DIY consumers also value the in-person help from the experts at Lowe’s stores that is difficult for an online home improvement retailer to replicate. Recently lumber prices are up over 40% for the year. We are hearing about extreme shortages of lumber at Home Depot (HD) due to supply disruptions. Interest rates on home mortgages are hitting record lows–near 3%–boosting housing demand.

Quest Diagnostics Inc. (DGX)
As a leading provider of diagnostic information services, Quest Diagnostics has been vital in testing for COVID-19. At the start of the crisis, testing was limited and volume for Quest fell as much as 50% due to stay-at-home orders and the overwhelmed healthcare system, but the last few months have marked an uptick in testing. At the peak of the crisis, Quest accounted for nearly 50% of all COVID-19 testing across the US, and by June Quest was processing as many as 100,000 active infection tests and 200,000 antibody tests per day. As the US continues to increase testing for the virus, Quest management is confident that their scale will offer significant cost advantages compared to hospital-based labs and smaller regional players. The company’s nationwide footprint and extensive network of patient service centers would be difficult for another company to replicate from scratch.

DuPont de Nemours Inc. (DD)
DuPont CEO Ed Breen has a very strong capital allocation track record. He achieved a 700% return over his tenure at Tyco. COVID-19 has created headwinds for segments like transportation, but the pandemic helped increase sales of the company’s Tyvek personal protective equipment (PPE) by 55%. Once shutdowns are lifted, management is expecting demand for leading products like Kevlar and Nomex will normalize as people spend less time working from home. DuPont still plans to sell off and merge their nutrition business with International Flavors & Fragrances in the first quarter of 2021, which would further tighten their focus on a smaller portfolio of products.

UnitedHealth Group Inc. (UNH)
As the largest health insurer in the US, UnitedHealth has seen positive tailwinds from deferred elective procedures due to social distancing policies. The deferring of procedures caused earnings for the June quarter to double, but management reaffirmed their guidance for 2020 indicating that they believe the benefit will be short-lived once stay-at-home orders are lifted and elective procedures normalize. The company generates healthy annual cash flow of $19 billion. It has a top three pharmacy benefit manager in OptumRx and an analytics platform in Optum Insight which means the company can interact more with their patients during the health care process. This can create a network effect as patients who utilize more of UnitedHealth’s services can take advantage of discounts that would be hard for smaller regional competitors to replicate.

Detractors to the quarter:  Our outlook on a cross section of positions with a negative impact on the portfolio for the quarter ended 6/30/2020.

Berkshire Hathaway Inc. (BRKB)
Berkshire Hathaway has suffered from major exposures to insurance, banking, energy and aerospace industries. According to the Wall Street Journal, property casualty insurance losses tied to Covid-19 are estimated to come in between $50 to $100 billion. This is the largest loss in history. Zero interest rates also diminish the value of Berkshire’s insurance float while negatively impacting bank net interest margins. Banks, as measured by the KBW Bank Index recently traded under 85% of book value—the cheapest since the early 1990s thrift crisis. Jet engine demand has crashed negatively impacting Precision Castparts. The stock is very cheap and represents good value selling close to book value with over $130 billion in cash.

Molson Coors Beverage Co. (TAP)
While many types of alcohols saw record sales during the stay-at-home orders, non-craft beer was not one of them. Major brands for Molson Coors, such as Coors Light and Miller Lite, saw their sales decline as bars, restaurants and sports venues shut down. The pandemic has also accelerated consumers’ changing alcohol preferences from beer to hard seltzers and marijuana. Still, the company has a powerful North American distribution network and is working hard to develop attractive offerings in hard seltzers, wine spritzers, CBD drinks and hard coffee.  Molson Coors has a history of survival.  Molson was founded in 1786 while Coors was founded in 1873. The stock is selling at one of the lowest valuations in a decade.

Philip Morris International Inc. (PM)
Philip Morris is making great strides with their smokeless, heated tobacco product IQOS that was recently approved by the FDA. It greatly reduces the risk for those who enjoy the taste of nicotine. This product is seeing sales growth from 15%-40% throughout the world.  The company continues to evolve as they are focusing heavily on ESG (Environmental, Social, and Governance), recently putting out a 192-page report.

Biogen Inc. (BIIB)
In June, a judge in West Virginia ruled that the patent for Biogen’s drug Tecfidera was invalid. While Biogen intends to appeal the ruling their chances for success are not high. Mylan (MYL), who brought the lawsuit, has said they will start producing biosimilars as soon as possible. In 2019, Tecfidera had sales of $4.4 billion which was around 31% of Biogen’s total revenues. Despite the setback from Tecfidera, Biogen still has a promising pipeline, headlined by their Alzheimer’s drug Aducanumab, and a fast-growing drug in Spinraza for spinal muscular atrophy (SMA). In 2019, sales of Spinraza grew 22% year-over-year to over $2 billion. Meanwhile management at Biogen is confident the FDA will approve Aducanumab, giving them another potential avenue for growth.  Biogen had over $4.8 billion in cash and equivalents and sells for less than 12 times earnings.

Medtronic plc (MDT)
Medtronic has been hit by the pandemic as elective surgeries have been postponed. It is the largest pure-play medical device maker and is utilizing advances in technology to attack a wide range of chronic conditions in diabetes, neurology, cardiac care and spinal conditions. The management is very innovative and the company has a fortress balance sheet with over $6 billion in free cash flow.

Merck & Co., Inc. (MRK)
Merck is one of the many companies currently working on producing a COVID-19 vaccine. In May they bought the company Themis, which has a COVID-19 vaccine in development based on an existing measles vaccine. Merck has also teamed up with the nonprofit group IAVI to develop a vaccine based on their already existing Ebola vaccine. With the sheer number of companies attempting to develop a COVID-19 vaccine, it remains unlikely that any one company will be the first to succeed, however Merck’s size and vast resources make them a better bet than most. Even if their vaccine efforts fail, Merck could benefit in the long run from a positive change of perception. Recently, the FDA approved animal health drug Bravecto for dogs to treat ticks and fleas. The fundamentals for the pet business are strong and we are monitoring many stocks in the space including Zoetis and IDEXX Labs. However, the biggest value driver for Merck is in battling cancer through their PD-1 drug Keytruda which has the potential to be the top selling drug globally by 2023.

In Closing

This pandemic has been horrible for many nonessential segments of the economy and has accelerated digital trends from years to months. We have never seen such a high percentage (over 90%) of the world’s economies drop into recession nor have we seen such a swift and powerful response by the US Federal Reserve. They have aggressively cut rates to zero, expanded their balance sheet by three trillion to $7.2 trillion and are buying junk bonds for the first time in history. M2 money supply has been growing at a 24% annual clip. Total government stimulus is running $5 trillion through June. This is more than double what was administered in the 2009 recession, in a fraction of the time. It has totally distorted the bond market. The ten-year treasury rate recently dropped under 0.6%.  Rampant speculation has returned following exciting stories with little cash flow.  With interest rates at 5000-year lows and the printing presses rolling we believe purchasing power risk is rising. $1 in 1940 would require $19 today. The Fund portfolio is currently far more attractive based on measures of earnings yield, return on equity and free cash flow yield than anything we are seeing in the fixed income market. We utilize years of cumulative knowledge and ownership not only to mitigate risk but to be prepared for double play opportunities by knowing intimately the fundamentals of each investment. Rather than trying to predict markets we try to research and monitor daily the operating reality of great managers and businesses that can endure the most challenging economic conditions. There are no shortcuts when protecting one’s hard earned savings.  Andy Grove, one of the greatest technology CEOs of Intel wrote about crisis investing. “Bad companies are destroyed by crisis, good companies survive them, great companies are improved by them.”

We appreciate your trust.

Jeff Auxier

 

Before investing you should carefully consider the Fund’s investment objectives, risks, charges and expenses.  This and other information is in the prospectus, a copy of which may be obtained by calling (877) 328-9437 or visiting the Fund’s website.  Please read the prospectus carefully before you invest.

Fund returns (i) assume the reinvestment of all dividends and capital gain distributions and (ii) would have been lower during the period if certain fees and expenses had not been waived.  Performance shown is for the Fund’s Investor Class shares; returns for other share classes will vary.   Performance for Investor Class shares for periods prior to December 10, 2004 reflects performance of the applicable share class of Auxier Focus Fund, a series of Unified Series Trust (the “Predecessor Fund”).  Prior to January 3, 2003, the Predecessor Fund was a series of Ameriprime Funds.  The performance of the Fund’s Investor Class shares for the period prior to December 10, 2004 reflects the expenses of the Predecessor Fund. 

The Fund may invest in value and/or growth stocks. Investments in value stocks are subject to risk that their intrinsic value may never be realized and investments in growth stocks may be susceptible to rapid price swings, especially during periods of economic uncertainty. In addition, the Fund may invest in mid-sized companies which generally carry greater risk than is customarily associated with larger companies. Moreover, if the Fund’s portfolio is overweighted in a sector, any negative development affecting that sector will have a greater impact on the Fund than a fund that is not overweighted in that sector. An increase in interest rates typically causes a fall in the value of a debt security (Fixed-Income Securities Risk) with corresponding changes to the Fund’s value.

Fund holdings and sector allocations are subject to change and should not be considered a recommendation to buy or sell any security.

Foreside Fund Services, LLC, distributor.

The S&P 500 Index is a broad-based, unmanaged measurement of changes in stock market conditions based on 500 market-capitalization-weighted widely held common stocks. The Dow Jones Industrial Average is a price weighted index designed to represent the stock performance of large, well-known U.S. companies within the utilities industry. The S&P 500 Equal Weight Index (EWI) is the equal-weight version of the widely used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight (0.2%) of the index total at each quarterly rebalance.  The Russell 2000 index is an index measuring the performance of approximately 2,000 smallest-cap American companies in the Russell 3000 Index, which is made up of 3,000 of the largest U.S. stocks. It is a market-cap weighted index. The MSCI Emerging Market Index captures mid and large caps across more than two dozen emerging market countries. The index is a float-adjusted market capitalization index and represents 13% of global market capitalization. The KBW Bank Index is a benchmark index for the banking sector made up of 24 banking stocks selected as indicators for large U.S. national money center banks, regional banks and thrift institutions. One cannot invest directly in an index or average.

The views in this shareholder letter were those of the Fund Manager as of the letter’s publication date and may not reflect his views on the date this letter is first distributed or anytime thereafter.  These views are intended to assist readers in understanding the Fund’s investment methodology and do not constitute investment advice.

This Internet site is not an offer to sell or a solicitation of an offer to buy shares of the Fund to any person in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. Foreside Fund Services, LLC. Distributor (www.foreside.com) | Hosted by Computer Link Northwest, LLC.