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Longleaf Partners 2Q17 Letter – FedEx, Wynn Resorts, CONSOL, Chesapeake, CNH, Level 3, Fairfax

Longleaf Partners Fund Commentary

  • Gained 3.91% in 2Q17 vs. S&P 500 of 3.09%; YTD return of 7.97% vs. S&P 500 of 9.34%
  • Outperformance during the quarter is notable given high cash weight and minimal exposure to what drove the index (Fund had limited Technology and Health Care)
  • Feel that vast majority of companies in Tech and Health Care are exhibiting dangerous signs of overvaluation

Wynn Resorts

  • Luxury gaming and hotel operator with prime properties in Las Vegas, Macau, and Boston was the largest contributor during the quarter
  • As Macau’s rebound accelerated, Palace property continued to ramp up strongly without cannibalizing legacy Peninsula property nearly as much as the market feared
  • Reported a solid quarter in Las Vegas and announced that phase one of its golf course redevelopment will be a more prudent project than anticipated
  • Construction is on track for the Boston property to open in 2019

FedEx

  • One of the largest package delivery networks contributed in the quarter
  • Continued its earnings momentum driven by revenue strength and margin gains in the Express segment
  • Ground segment revenues stayed strong, although margins were down – believe that it is close to a point where Ground margins turn around as the large scale investment in new hubs slows
  • Communicated that integration of its TNT acquisition from last year is going well
  • Some investors panic around Amazon hurting FedEx as a competitor has also begun to subside, for logical reasons related to FedEx’s physical scale and last mile delivery

Alphabet

  • Diversified internet company with strong positions worldwide in search, video, mobile and more was another contributor in the quarter
  • Revenue growth accelerated and margins were better than expected
  • Company bought back shares and continued to simplify its Other Bets segment while growing its lead in driverless cars
  • Company’s core business growth will continue, YouTube and Other Bets offer additional harder-to-quantify upside and the strong balance sheet with substantial cash provides attractive downside mitigation

CONSOL Energy

  • Appalachian natural gas and coal company was a detractor in the quarter
  • Operating items within the company’s control were generally positive
  • Weaker gas prices weighed on the stock and its peers
  • CONSOL’s partner in the pipeline company Cone Midstream sold its interest at a price above where we carry CONSOL’s identical assets
  • Late in the quarter, Rice sold to EQT at a price that implied a significantly higher value for CONSOL’s gas operations than current stock price

Chesapeake Energy

  • One of the largest US producers of natural gas, oil, and NGLs was a detractor
  • Weak commodity prices impacted the oil and gas group overall but CHK’s extremely high correlation to oil prices instead of gas prices was surprising
  • Although CHK’s production is primarily weighted to gas, meaningful and increasing % of cash flow going forward will come from oil and NGLs
  • CEO Doug Lawler will make prudent asset sales when the price and time are right

CNH Industrial

  • Maker of agricultural equipment, commercial vehicles and construction equipment, contributed again this quarter
  • Core agricultural business reported its best results since 2013 – segment continued to see unit demand stabilize and pricing power remained intact
  • Best news was the earlier-than-expected upgrade of CNH to investment grade status which is more meaningful for this company than most others
  • Upgrade will increase the efficiency of the financing business while likely freeing up over $1Bn of new excess capital for more productive uses including share repurchase

Level 3 Communications

  • Multinational telecommunications and Internet service provider made a major announcement
  • CEO Jeff Storey was named the successor to CEO Glen Post at CenturyLink whose acquisition of Level 3 should close in a few months
  • Thrilled that Storey’s stellar team who created 182% in shareholder return since he took over in 2013 will be running operations at the new CenturyLink

Fairfax Financial

  • Added Fairfax, a Canadian based insurance and reinsurance operator, to the portfolio
  • Southeastern previously owned the company for a decade and Longleaf had positions
  • Fairfax is underwriting more successfully than when we previously owned it and is about to complete a value-accretive merger with Allied World
  • Because the merger is on the come and is holding a large sum of cash that is not producing income, near-term reported earnings per share are well below long run earnings power

Outlook

  • Fund’s P/V ratio is higher than usual in the mid-70s% as is the cash level at 26%
  • Outlook remains much the same as last quarter: believe current roster of companies has the ability to produce solid results even in a potentially difficult environment
  • While current elevated market can be frustrating, we take comfort in our long track record of patience and discipline eventually being rewarded
Image Source: Longleaf Partners
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