First Pacific Advisors, LLC

Transcription

1 FPA U.S. Value Fund, Inc. Gregory R. Nathan, Portfolio Manager June 6, 2016

2 FPA U.S. Value Fund, Inc. Fund highlights Investment objective The primary objective is long-term growth of capital. Current income is a secondary consideration. Goal Generate returns in excess of the S&P 500 Index over full market cycles Investment philosophy Avoid permanent capital impairment Invest in quality businesses at attractive valuations Preference for companies with good management 1

3 FPA U.S. Value Fund Portfolio Manager: Gregory R. Nathan Professional background 14 years investment experience Was most tenured senior analyst of FPA Contrarian Value Key contributor for FPA Contrarian Value Deep expertise: the skill and experience to identify quality companies selling for a discount Professional biography : Senior Analyst for FPA Contrarian Value : Managing Member of Coldwater Asset Management, LLC : Analyst for FPA Contrarian Value : Analyst for Lakeway Capital : Earned Bachelors Degree in Business Administration (with distinction) from the University of Michigan Alignment of interests Significant personal investment with over $1mm invested in the Fund (as of 3/31/16) 2

4 Investment philosophy Seek to avoid permanent capital impairment An investment discipline on business quality, valuation and financial leverage Diversification by number of investments and industry exposure Invest in quality companies at attractive valuations Typically looking for quality companies in healthy, growing industries that often appear misunderstood and/or out of favor Portfolio s returns can benefit from future above-average earnings growth, free cash flow that can be returned to shareholders as well as the potential for expanding earnings multiples Definition of quality Strong and enduring competitive positions Growing businesses within a growing industry resulting in growing earnings Current and/or prospective high returns on capital Current and/or prospective robust free cash flow generation Preference for companies with good management However, we may consider investments in good businesses that are not well-managed provided executives can be replaced and there is an ample discount to our estimate of intrinsic value The quality of the business and valuation are the most important investment criteria 3

5 Rules of engagement healthy, growing industry is a must Rule #1: Healthy industry with supply/demand balance helps ensure rational competition and pricing strength over time Rule #2: Companies must operate in secularly growing industries Rule #3: Identify the strongest players with sustainable competitive advantages Rule #4: Purchase these companies at attractive valuations Follow these four rules = good odds of above average returns over time Share price return 300% 250% 200% 150% 100% 50% 0% -50% -100% Growing sub-industries: Declining sub-industries: CVS Health Corporation (Drug Retail) Best Buy Co., Inc. (Consumer & Electronics Retail) Walgreens Boots Alliance, Inc. (Drug Retail) Circuit City Stores Inc. (Consumer & Electronics Retail) The Home Depot, Inc. (Home Improvement Retail) Staples, Inc. (Specialty Stores) Lowe's Companies, Inc. (Home Improvement Retail) Office Depot, Inc. (Specialty Stores) S&P 500 Index Source: Capital IQ. Past performance is no guarantee of future results. Please refer to the back of the presentation for important disclosures. 4

6 Portfolio construction Broad market capitalization The Fund will generally invest in companies with market caps of $2 billion or more, at time of initial purchase Allows us to invest wherever the best opportunities arise U.S. companies At least 80% of net assets will be invested in U.S. companies 1 Opportunistic foreign investments Up to 20% of net assets may be invested in non-u.s. companies Appropriate diversification Typically 20 to 40 companies Individual positions will not exceed 5% of total assets at time of purchase Typically, target average position size of 3% to 4% of total assets Cash typically will not exceed 10% of net assets 1 Includes companies which alone or on a consolidated basis derive the highest concentration of annual revenue, earnings, or assets from goods produced, sales made, or services performed in the U.S. 5

7 Investment process ~3,000 $2B+ Market Cap Companies ~900 Return on Capital > 10% ~250 Forward P/E < 15x ~100 Typically Forward EPS Growth > 10% ~50 Overlay research and analysis to determine which companies meet quality criteria Build low/base/high cases; choose best risk-adjusted return 6

8 Sell discipline Reasons to sell The market has recognized the company s quality with a valuation re-rating such that estimated future returns from that new price are projected to be below average An investment thesis is proven wrong Will not rationalize holding an investment even if the price/valuation has declined A superior opportunity becomes available 7

9 Performance Return (%)* As of Date: 3/31/16 Q Q Since 9/1/15 1 Year 5 Years 10 Years FPA U.S. Value Fund S&P Russell Morningstar Large Blend Average Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. This data represents past performance and investors should understand that investment returns and principal values fluctuate, so that when you redeem your investment it may be worth more or less than its original cost. Current month-end performance data may be obtained via or by calling toll-free, *On September 1, 2015, the Fund changed its name to FPA U.S. Value Fund, Inc., and the current portfolio manager assumed management of the Fund on that date. Contemporaneous with this change, the Fund transitioned to its current investment strategy. Performance prior to September 1, 2015, reflects the performance of the prior portfolio manager and investment strategy. Performance prior to September 1, 2015 is not indicative of performance for any subsequent periods. The transition took place during time period from September 1, September 30, A redemption fee of 2% will be imposed on redemptions within 90 days. Expense ratio as of most recent prospectus is 0.97%. Calculated using Morningstar Direct. Periods greater than one year are annualized. 8

10 FPA U.S. Value Fund as of March 31, 2016 Sector FPA U.S. Value Fund S&P 500 Consumer Discretionary* 35.67% 12.90% Health Care 26.37% 14.28% Industrials 10.08% 10.13% Financials 8.85% 15.63% Consumer Staples 4.86% 10.40% Information Technology 2.08% 20.83% Energy 0.00% 6.76% Utilities 0.00% 3.45% Materials 0.00% 2.83% Telecommunication Services 0.00% 2.79% Total 87.91% % Other 2.10% Cash and equivalents (net of liabilities) 9.99% *Houghton Mifflin Harcourt, included in the consumer discretionary sector, derives a majority of its revenue and profit from its Education segment, which primarily provides education solutions to educational institutions for the pre-k 12 market. Portfolio composition will change due to ongoing management of the Fund. Past performance is no guarantee of future results. Please refer to the back of the presentation for important disclosures. 9

11 FPA U.S. Value Fund portfolio as of March 31, 2016 FPA U.S. Value Fund S&P Month Forward P/E 12.2x 16.9x Price/Book 2.6x 2.8x Return on Equity 18.6% 17.0% EPS Growth Historical (2-year, $weighted median) 11.0% 7.1% EPS Growth Forecast (2-year, median) 11.7% 11.9% Debt/Equity 0.2x 0.1x Weighted Average Market Cap (billions) $49.5 $141.8 P/E (Price-to-Earnings Ratio) is a ratio for valuing a company that measures its current share price relative to its per-share earnings. Price to book ratio (P/B Ratio) is a ratio used to compare a stock's market value to its book value. Earnings Per Share (EPS) is the portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability. Portfolio composition will change due to ongoing management of the Fund. Past performance is no guarantee of future results. Please refer to the back of the presentation for important disclosures. 10

12 Investment case study

13 Investment case study: what high quality industries are these? Industry A Industry B Recession Resistant Yes Yes Last 10 Years EBITA CAGR 4.3% 9.8% Return on Capital (average)* 15.1% 11.9% YTD Return (average)* 4.4% -11.1% P/E 2016E (average)* Last 10 Years Avg. Forward P/E* Dividend Yield (average)* 2.0% 1.5% Pay-out ratio (average)* 46.0% 23.0% % of S&P 500* 6.5% 1.4% Fund's Exposure (3/31/16) 0.0% 20.3% Source: Capital IQ *As of 5/31/16. Past performance is no guarantee of future results. Please refer to the back of the presentation for important disclosures. 12

14 Investment philosophy: let the trend be your friend 13

15 What do all of these people have in common? 14

16 The baby boomer generation 15

17 The one thing guaranteed in life you AGE! As you get older, especially after age 65, you take a lot more prescription drugs As of 12/16/15 CVS Analyst Day report. 16

18 The aging U.S. population will help fuel Rx expenditures The compound annual growth rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer than one year. 17

19 Building blocks of growing U.S. prescription expenditures New Drug Therapies + Existing Rx Volume Growth + Brand Drug Price Inflation of Existing Therapies, net of impact from negotiated discounts and rebates by pharmacy benefit managers = ~6% CAGR for Next 10+ Years 18

20 New drug therapies Specialty Rx growth will be a large driver of increased pharmacy spend 19

21 Existing Rx volume growth drivers Aging Population: see previous slides Population Growth: 0.7%-0.8% CAGR Increased utilization from Source: CVS Health Internal Analysis; Medicare Trustees Report, 2015; Avalere Medicaid Model, September 2015; McKinsey MPACT 6.2, September 2014; CBO Public Exchange Estimates, March 2015; Accenture, 2015; Congressional Budget Office. Model assumes no additional Medicaid expansion in the 20 non-expansion states, further Medicaid expansion could improve long-term covered lives outlook. Figures may not foot due to rounding. Source: McKesson 2013 Investor Day, Express Scripts Drug Trend reports, Avondale Partners estimates Rising Prevalence of Chronic Conditions 20

22 Patent-protected brand Rx price inflation of existing therapies Historically, high-single to low-double digit annual increases on list prices Impact partially offset by negotiated discounts and rebates by pharmacy benefit managers (PBMs) In 2015, the average list price for patent-protected brands rose 12.4%, but the net growth after discounts was 2.8%; for 2014, it was 14.3% and 5.1%, respectively (according to IMS Health). 21

23 Best risk adjusted way to invest behind this trend? The pharmaceutical supply chain: large scale wholesale distributors & retail/mail pharmacies Wholesalers distribute brand, generic and specialty Rx to retail and mail order pharmacies, hospitals, clinics and physician offices, which in turn dispense and/or administer Rx to patients 22

24 Making a case for the pharmaceutical supply chain Large scale distributors and retail/mail pharmacies are a necessary, irreplaceable and efficient form of infrastructure to get Rx from manufacturers to consumers As a result, they get to take a rising toll on an ever increasing flow of traffic 23

25 Pharma supply chain underperformance: not a surprise Rx channel has underperformed in prior election years, but better days may lie ahead Sources: Bloomberg, J.P. Morgan 24

26 Pharma supply chain: attractively valued The pharma supply chain trades at a meaningful discount to the market, yet is expected to grow faster The big three distributors (McKesson, AmerisourceBergen, Cardinal Health) trade at a ~20% discount, based on consensus estimates P/E* EPS* 2016E 2017E 2018E 2016E 2017E 2018E CAGR McKesson (MCK) 14.5x 12.8x 11.2x % AmerisourceBergen (ABC) 13.5x 12.5x 11.1x % Cardinal Health (CAH) 14.0x 12.6x 11.3x % Walgreens Boots Alliance (WBA) 16.5x 14.5x 12.7x % CVS Health Corp (CVS) 16.6x 14.7x 13.1x % Median 14.5x 12.8x 11.3x 12.6% Average 15.0x 13.4x 11.9x 12.4% S&P x 15.7x 14.0x % *EPS based on consensus estimates from Capital IQ; prices as of 5/31/16 25

27 Pharmaceutical distributors: particularly cheap With the stock market up and pharma distributors down mid-high teens YTD, these companies now trade at the largest discount to the S&P 500 since 2009 Historically, on average they have traded at a slight premium to the market Source: FactSet, Avondale Partners 26

28 Distributors: recession resistant businesses Drug Wholesaler and Pharmacy Sales - Low Correlation to the Consumer (quarterly frequency) Source: Company Data, Centers for Medicare and Medicaid Services, Office of the Actuary, United States Census, Avondale Partners 27

29 Distributors: operating within a healthy, growing industry Above average industry and GDP growth Projected National Expenditures on Prescription Drugs and U.S. GDP Growth Source: Company Data, Centers for Medicare and Medicaid Services, Office of the Actuary, United States Census, Avondale Partners 28

30 U.S. pharma supply chain: highly consolidated industry U.S. pharma distribution is very concentrated with top 3 players controlling 90%+ market share Source: Barclays Research, Company Data 29

31 Rational competition = few distribution contracts change hands Over the past few years, most major contract changes were due to the formation of JVs between large distributors and drugstore chains with a focus on generic procurement Source: AIS, Company Filings, Evercore ISI 30

32 Big three distributors: generate consistent operational performance Regardless of the economic environment, the big three distributors operating margins are typically within a fairly narrow band Helped by growing volumes and increased Rx pricing over time Margins appear low because a large portion of the revenue they recognize is based on expensive brand Rx list prices while in comparison they receive a relatively small fee for their services Source: Company Data, Avondale Partners 31

33 Pharma distributors: high quality business characteristics The big three distributors have typically generated around a mid-teens return on invested capital Source: Company Data, Avondale Partners 32

34 Pharma distributors: business mix Despite brand Rx making up the largest piece of revenues due to high prices, generics make up a larger portion of gross profit because there is a lot more generic volume distributed coupled with higher gross profit dollars per Rx Source: Pembroke Consulting estimates, Avondale Partners report dated 4/18/16. 33

35 Generics: everyone wins except the brand manufacturer Despite a large price decline, much of the profits the brand manufacturer enjoys prior to patent expiration is transferred to the various supply chain participants as well as the payer/consumer Allows large scale distributors, retail pharmacies and PBMs to make higher gross profit dollars per prescription of a generic non-exclusive compared to the brand Rx $ Gross Profit $100 $90 $80 $70 $60 $50 $40 $30 $20 $10 $0 Average Brand Drug Based on a $135 price Retail pharmacy $11.50 Brand Manufacturer $78.50 Source: J.P.Morgan, data as of 2009 for illustrative purposes only. Distributor $2.50 PBM $2.00 Avg. Non-Exclusive Generic Based on a $51 price Payer/consumer savings Retail pharmacy $13.00 PBM $7.00 Generic Manufacturer $7.00 Distributor $

36 Distributors sell spread on generics increasing over time Over the past few years, large scale distributors and pharmacies have formed JVs to combine their generic purchasing volume to drive greater discounts from manufacturers Major trend by the largest dispensers of Rx to outsource their procurement of generics; in the past they mostly just outsourced procurement and distribution of brand Rx Walgreens now makes up 30% of ABC s revenue contract runs through 2026 CVS now makes up 27% of CAH s revenue contract runs through 2023 Walmart recently agreed to expand its relationship with MCK to include generic sourcing Source: J.P.Morgan, Company Filings 35

37 Generic conversions: trend continues but to a smaller degree Over the next five years, a greater proportion of distributors profit growth will come from existing therapy volume growth and new therapy introductions, particularly from specialty Rx Source: McKesson 2013 Investor Day, Express Scripts Drug Trend reports, Avondale Partners estimates 36

38 Opportunity to consolidate European pharma distribution While the U.S. market is highly consolidated, Europe is quite fragmented Two of the three largest European distributors are owned by U.S. companies MCK owns a majority of Celesio while WBA owns 100% of Alliance Boots Expect further tuck-in acquisitions by these companies in the future Source: Barclays Research The U.S. Pharma Supply Chain Goes Global report dated 12/7/15. 37

39 U.S. healthcare: a very wasteful system While the utilization of healthcare will increase due to the aging population, the U.S. cannot afford to spend 18%+ of its GDP on healthcare, which is twice the amount spent by other developed countries This will force system-wide participants to be more efficient to drive out waste Source: consumersunion.org 38

40 Pharma distribution within the context of U.S. healthcare Despite receiving a lot of political attention, the reality is prescription drugs only make up ~10% of national health expenditures Pharma distribution fees are a sliver of this spend 39

41 U.S. healthcare system excess: mostly non-pharma related Largely due to a multi-payer system, the U.S. pays more for its brand Rx, but this is partially offset by rebates garnered from PBM formulary management and high generics utilization as a result of automatic substitution and a reliable supply chain Excess spend in pharma small compared to larger cost centers More current data is not available; the information presented above may differ from current spending. 40

42 Pharmaceuticals: one of the most cost-effective ways to reduce overall healthcare costs Bottom Line: proper utilization of prescription drugs helps lower the total cost of care for many diseases where reactive treatment in the most expensive settings such as hospitals ends up increasing overall healthcare costs 41

43 The importance of taking a long-term view Beginning 10 years ago, it took seven years for an investment in Home Depot to show material outperformance only to expand further over time. The key is to invest in: Strong players with sustainable competitive advantages Healthy, secularly growing industries Companies at attractive valuations Share price return Good odds of above average returns over time 250% 200% 150% 100% 50% 0% -50% -100% The Home Depot, Inc. (NYSE:HD) S&P 500 Index (^SPX) Source: Capital IQ. Past performance is no guarantee of future results. Please refer to the back of the presentation for important disclosures. 42

44 The importance of taking a long-term view YTD (as of 5/31/16) a majority of the U.S. pharma supply chain has materially underperformed the market AmerisourceBergen (ABC) -27.4% Cardinal Health (CAH) -11.6% Walgreens Boots Alliance (WBA) -8.7% McKesson (MCK) -7.0% CVS Health (CVS) -0.9% S&P 500 TR 3.6% Let s see what happens over the next 10 years Source: Capital IQ. Past performance is no guarantee of future results. Please refer to the back of the presentation for important disclosures. 43

45 Important Disclosures You should consider the Fund s investment objectives, risks, and charges and expenses carefully before you invest. The Prospectus details the Fund's objective and policies, charges, and other matters of interest to the prospective investor. Please read this Prospectus carefully before investing. The Prospectus may be obtained by visiting the website at by at crm@fpafunds.com, toll-free by calling or by contacting the Fund in writing. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. This data represents past performance and investors should understand that investment returns and principal values fluctuate, so that when you redeem your investment it may be worth more or less than its original cost. The Fund s expense ratio as of most recent prospectus is 0.97%. A redemption fee of 2% will be imposed on redemptions within 90 days. Current month-end performance data may be obtained by calling toll-free, The views expressed herein and any forward-looking statements are as of the date of the publication and are those of the Portfolio Management Team. Future events or results may vary significantly from those expressed and are subject to change at any time in response to changing circumstances and industry developments. This information and data has been prepared from sources believed reliable, but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data. Portfolio composition will change due to ongoing management of the Fund. References to individual securities are for informational purposes only and should not be construed as recommendations by the Fund, the Portfolio Manager, or the Distributor. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the security examples discussed. Investments in mutual funds carry risks and investors may lose principal value. Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Certain funds may purchase foreign securities, including American Depository Receipts (ADRs) and other depository receipts, which are subject to interest rate, currency exchange rate, economic and political risks; this may be enhanced when investing in emerging markets. Small and mid-cap stocks involve greater risks and they can fluctuate in price more than larger company stocks. Value stocks, including those selected by the portfolio managers for the Fund, are subject to the risks that their intrinsic value may never be realized by the market and that their prices may go down. In addition, value style investing may fall out of favor and underperform growth or other styles of investing during given periods. Securities selected by the portfolio managers using a value strategy may never reach their intrinsic value because the market fails to recognize what the portfolio managers consider to be the true business value or because the portfolio managers have misjudged those values. 44

46 Important Disclosures cont d Index Definitions: The Standard & Poor's 500 Stock Index (S&P 500) is a capitalization-weighted index which covers industrial, utility, transportation and financial service companies, and represents approximately 75% of the New York Stock Exchange (NYSE) capitalization and 30% of NYSE issues. Morningstar Large Blend Average consists of portfolios that invest in a variety of large US stocks. Stocks in the top 70% of the capitalization of the US equity market are defined as large-cap. The blend style is assigned to funds where neither growth nor value characteristics predominate. The Russell 2500 Index consists of the 2,500 smallest companies in the Russell 3000 total capitalization universe. The Russell 3000 Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization. This index is considered a measure of small to medium capitalization stock performance. This index does not reflect any commissions or fees which would be incurred by an investor purchasing the stocks it represents. Please consult your tax advisor regarding higher capital gains distributions due to a change in portfolio strategy. The FPA Funds are distributed by UMB Distribution Services, LLC, 235 W. Galena Street, Milwaukee, WI,