3 Buys and a Sell From Longleaf Mutual Funds

Summary: Southeastern Asset Management, led by founder and CEO Otis Mason Hawkins, manages $37 billion in equity assets under the Longleaf Partners family of mutual funds and in separately managed accounts. The Longleaf funds have consistently outperformed the market and been ranked among the nation's best mutual funds, with the flagship Longleaf Partners Fund having returned 11.5% annualized versus 9.0% for the S&P 500. Three attractive buys from its portfolio include Dillards Inc. (DDS), Disney Walt Co. (DIS) and Abbott Laboratories (ABT), and a conviction sell from the portfolio is Verizon Communications Inc. (VZ).

Memphis, TN-based Southeastern Asset Management, with $37 billion in equity assets under management and founded in 1975 by Chairman and CEO Otis Mason Hawkins, manages $15 billion under the Longleaf Partners family of mutual funds and an additional $22 billion in separately managed accounts. The Longleaf Partners Funds have consistently ranked among the nation's best performing mutual funds, with the flagship $9.6 billon Longleaf Partners Fund having generated 11.5% annualized return or 1,246% cumulative return since inception in 1987 versus 9.0% annualized or 686% cumulative for the S&P 500. The smaller $3.4 billion Longleaf Partners Small-cap fund and $2.2 billion Longleaf Partners International fund have both beaten their corresponding market averages during the last ten years, and both are ranked four stars by Morningstar. All of Longleaf's three funds follow a "value" approach to investing, seeking to acquire equities at prices substantially less than their intrinsic worth and selling them when they approach Longleaf's appraisal value of the underlying business.

The fund holds a concentrated portfolio of 45 positions, with almost two-thirds of its holdings in large-caps, 30% in mid-caps and the remaining less than 5% in small-cap equities. Its portfolio turnover is 15%-20% implying an average holding period of five to seven years. Based on the most recent SEC 13-F filing for the March 2011 quarter, we determined that the portfolio is over-weight services (42%) and financials (21%) sectors, and it is under-weight technology (11%), energy (11%), consumer (4%), basic materials (1%), healthcare (<1%) and utility (0%) sectors, compared to the weighting of these sectors in the overall economy.

The following summarizes its largest new buys and sells in the latest reported 13-F filing for the March 2011 quarter, and updated based on any 13-G filings since the end of the quarter:

• Services sector: Buy Dillards Inc. and Disney Walt Co., and Sell Verizon Communications Inc. Longleaf cut $700 million from its prior $11.1 billion position in the sector. It cut $476 million from its large $1.6 billion position in Disney Walt Co., $186 million from its $2.38 billion position in DirecTV, $118 million from its $267 million position in retail department store chain Dillards Inc., and it sold out of its $75 million position in Verizon Communications Inc.. On the balance, it added a new $97 million position in online travel services provider Expedia Inc. (EXPE), and it added $92 million to its $951 million position in News Corp. (NWS). The position in VZ was opened in the high-$20s in mid-2010, so their selling out while at a profit was well short of their average holding period and may be interpreted as a sign of their bearishness on the stock. VZ sells for a forward price-to-earnings (P/E) ratio of 14 based on fiscal year 2012 analyst earnings estimates, which is near the top of their typical P/E trading range. The stock is up almost 50% in the last year while earnings are flat year-over-year but are projected to grow over 15% next year, while revenues are projected to grow at 4%-5%. The stock appears over-valued at this level, and there seems to be significant risk to the downside while the upside appears limited. The position in DDS was opened probably in the mid-$20s in the summer of 2007, so Longleaf selling a portion of that holding at a profit in the $40s last quarter is just profit-taking and does not have any conviction. The stock has been strong, up 150% for the year, but fundamentals have been supportive of that rise and the stock still trades at a respectable 12 times forward P/E, near the bottom- to mid-range based on its historic P/E range. Just in the last quarterly report in mid-May the company annihilated analyst estimates reporting $1.27 v/s the 91c estimate for the March 2011 quarter. This is a great story, and with only two analysts providing forward estimates for the stock, DDS is probably also under-followed. While there is a risk in buying such a high-flyer, the fundamentals in DDS seem to support the rise, and we would be buyers on any pullback into the breakout base near $40, which is likely given the recent meteoric rise. The position in DIS was opened in the low- to mid-$20s in the summer of 2001, so Longleaf selling it in the $40s last quarter was just profit-taking. DIS stock is trading at a forward 15 P/E, near the low-end of its historic P/E range, and it has pulled back recently more than 15% and analyst targets continue to be in the $50s. It is an attractive buy at these levels as earnings are projected to continue growing at a 15%-20% annual clip in the short-term.
• Technology sector: Longleaf cut $375 million from its $3.1 billion prior quarter position in the sector. It cut $322 million from its $464 million position in computer security software provider Symantec Corp. (SYMC). The position in SYMC was opened in the $30 range in the summer of 2006, so the selling of a portion of that position in the $50 range last quarter was profit taking. SYMC trades at a forward 30 P/E, near the top of its historic P/E range, but the company recently beat estimates in the latest March 2011 quarter and is projected to show continued steady growth in low double-digits going forward. Further, recent analyst actions have put targets on the stock in the low- to mid-$20s, which still leaves moderate upside from current levels. We believe SYMC is trading at a fair price, and is not an attractive buy or a conviction sell at current levels. After the End of the March 2011 quarter, Longleaf bought a new $86 million position in Fair Isaac Corp. (FICO), a developer of decision-making software for financial services, insurance, healthcare, retail and government sectors. FICO trades at a forward 15 P/E, near the low end of its historic P/E range. Recent analyst actions have all been upgrades, putting a target for the stock in the high-$20s to low-$30s, making this a hold at current levels.
• Healthcare sector: Buy Abbott Laboratories. Longleaf added a new $111 million position in pharmaceutical company Abbott Laboratories, its only position in the healthcare sector. ABT trades at a forward 11 P/E, near the bottom of its historic P/E range, while the company continues to beat analyst revenue and earnings estimates and is projected to continue to post growth in the low double-digits going forward. Twelve analysts rate it at a buy and only one a sell, with targets in the $60+ range, giving it an attractive upside from current levels in the low-$50s.
• Basic materials sector: During the quarter, Longleaf maintained unchanged their prior $200 million position in the sector. However, they filed a 13-G subsequent to the end of the quarter, indicating that they dropped their $140 million position in Worthington Industries, Inc. (WOR), a processor of diversified metals focusing on value-added steel for automotive, construction, hardware and aerospace markets. The position in WOR was opened in the $20 range in early 2007, and the stock has been volatile since dropping to $7 in the 2008/09 and rising three-fold from that lows, so Longleaf dropping that position in early May at close to a break-even after holding it for over four years is not necessarily indicative of their conviction in the sell decision. WOR is selling at a forward 12 P/E, near the bottom of its historic P/E range, while revenue and earnings are projected to increase strongly going forward, with earning projected to rise 50% year-over-year for the fiscal year ending May 2011 and 30%+ for the next year. However, earnings are cyclical based on the macro-economic cycles, and a 12 P/E is probably fairly valued based on peak earnings. Also, the stock trades at a 0.6 price-to-sales (PSR), which is mid-range within its historical 0.45-0.75 range.

Table

Company	Ticker	Action	Market Value at end of March 2011 Quarter	Change in Value from Prior Quarter	Percent of Portfolio	Percent Shares Owned
New 13G 5% Ownership Filing Since End of March 2011 Quarter
Texas Industries Inc.	TXI	New	$231 million	$231 million	0.9%	20.8%
Fair Isaac Corp.	FICO	New	$86 million	$86 million	7.3%	0.3%
Worthington Industries Inc.	WOR	Drop	$0 million	$140 million	0.0%	0.0%
Top Buys and Sells
Pioneer Natural Resources	PXD	Cut	$ 599 million	($686) million	2.35%	5.04%
Disney Walt Co.	DIS	Cut	$ 1134 million	($476) million	4.45%	1.39%
Symantec Corp.	SYMC	Cut	$ 142 million	($322) million	0.56%	1.02%
DirecTV	DTV	Cut	$ 2193 million	($186) million	8.61%	6.10%
Loews Corp.	L	Add	$ 1190 million	$162 million	4.67%	6.75%
Dillards Inc.	DDS	Cut	$ 150 million	($118) million	0.59%	7.15%
Abbott Labs	ABT	New	$ 111 million	$111 million	0.43%	0.15%
News Corp.	NWS	Add	$ 1048 million	$97 million	4.11%	3.26%
Expedia Inc.	EXPE	New	$ 97 million	$97 million	0.38%	1.72%
Travelers Companies Inc.	TRV	Add	$ 771 million	$95 million	3.03%	3.10%
Chesapeake Energy Corp.	CHK	Cut	$ 2660 million	($84) million	10.44%	12.06%
Verizon Communications Inc.	VZ	Drop	$ 0 million	($74) million	0.00%	0.00%
Top Holdings
Dell Inc.	DELL	Add	$ 2125 million	$18 million	8.34%	7.76%
Yum! Brands Inc.	YUM	Cut	$ 1522 million	($32) million	5.97%	6.36%

Credit: Historical fundamentals including operating metrics and stock ownership information were derived using SEC filings data, I-Metrix® by Edgar Online®, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.