Adams Diversified Equity Fund, Inc.
Q2 2019 Earnings Call Transcript

Published: 25 Jul 2019

[Operator:]

Good afternoon and welcome to the Adams Diversified Equity Fund Semi Annual Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.I would now like to turn the conference over to Lyn Walther, Director, of Shareholder Communications. Please go ahead.

[Lyn Walther:]

Good afternoon and thank you for joining us today, as we discuss the results for Adams Diversified Equity Funds for the first six months of 2019. With me today are Mark Stoeckle, the fund's Chief Executive Officer; Brian Hook, our Chief Financial Officer; and Janis Kerns, our General Counsel.This conference call contains statements, which are considered Forward-Looking Statements within the meaning of the U.S. Securities Exchange Act. These statements reflect Fund Management's current views with respect to future events and the Fund's financial performance over the past six and 12 months, and are not guarantees of our future performance.Although forward-looking statements made today are based on what management believes are reasonable assumption, these statements are subject to risks, uncertainties and other important factors that could cause our actual performance, returns or investment decisions to be materially different from what we project. We assume no obligation to revise, correct or update these statements.I will now turn the call over to Mark Stoeckle for his remarks.

[Mark Stoeckle:]

Thanks, Lyn, and thanks to everyone for joining us today, to talk about the first six months of 2019.I’m going to give some brief remarks, talk a little bit about what moved the fund in the first six months and then turn over to Brian to give some details on performance and then we'll take your questions.After a speed sell off at the end of 2018, the stock market did reverse course in the first half despite several economic and geopolitical headwinds, while there were signs of slowing in manufacturing both domestically and globally the overall U.S. economy remains relatively strong with unemployment at historic lows and inflation under control.If you remember, we began the year with the Government shut which ended in late January, making it the longest shutdown on record. We also saw trade negotiations with China breakdown and the U.S. threatened to raise tariffs on $300 billion of Chinese imports, tensions also escalated in the Middle East. All of this began and take a toll in May.However in June, the Federal Reserve reassured the market that it would be accommodative if economic growth were too slow, which comps markets and had investors wondering how many times the Fed might cut rates before the end of the year. With this as a backdrop the S&P 500 increased 18.5% its strongest first half returns since 1997, we are very pleased with our performance which exceeded our benchmark by 1.4%.Our fund generated 19.9% return driven by strong stock selection across several sectors. The strength in the market was broad-based with all sectors generating positive returns. The strongest contributors to our performance came from technology, healthcare and consumer staples. Our technology investments increased 28%, our holdings in Microsoft and Adobe Systems were standouts and continue to benefit from enterprise spending on cloud computing.Another key trend in the technology sector is the migration from cash to plastic driven by e-commerce growth, our holdings in Visa and MasterCard benefited from this trend. Healthcare was an interesting combination of what we owned and what we didn't own.We were underway by a technology, which was a very good decision, but also had one position in the best performing stock in Biotech Alexion Pharmaceuticals, two of the worst-performing stocks in biotech were AbbVie and Biogen, down 19% and 22% respectively, where we had very little to no exposure which also contributed to performance.And we had much the same situation in the pharmaceutical industry group where we are also underweight, contributing nicely to performance. ZOVATUS and animal Health Company was a standout stock we owned up over 20% for the six-month period.Investors seem to favor defensive sectors in the first half such as consumer staples, which increased 21.2%. Our holdings in Costco and MonaLisa were standouts, Dave Schiminger our staples analysts have done a really nice job identifying companies with good business models in this sector where there are few and far between.As we look to the second half of the year, we remain constructive in our outlook on the market. While the economy is showing some signs of slowing the consumer does not appear to be. Given the consumer spending accounts for two thirds of GDP we do not expect a meaningful slowdown.The early returns from company's reporting the second quarter results has been encouraging, just last night we heard from portfolio holdings Chipotle Mexican Grill, Texas Instruments, Edwards Lifesciences and AT&T, which reported better than expected results.We have a long way to go to get through all the earnings, but we are certainly off to a good start. One of the overhangs in our view is our concerned about the impact of ongoing trade disputes and escalating global tensions might have on the market. We will be watching this at a company level very closely.I will now turn the call over to Brian to provide some details on our performance.

[Brian Hook:]

Thanks Mark. For the first six months of 2019 the total return on the fund's net asset value was dividends and capital gains reinvested was 19.9%. This compares to an 18.5% total return for the S&P 500 and a 17.7% total return for the Lipper large cap core funds averaged over the same time period.The total return on the market price of fund shares for the period was 23.3%. For the past 12 months the fund total return on that asset value was 13.7% comparable figures for the S&P 500 and Lipper Large Cap Core Funds Average were 10.4% and 9.3% respectively.The fund for return on market price for that same time period was 15.0%. During the first half of 2019 the fund bought back $7.2 million worth of its shares at a weighted average discount to net asset value of 13.7% resulting in a $0.01 increase in net asset value per share.Also during the period the fund distributed $10.6 million to shareholders from distributable earnings. Even with these shareholders pay off the net asset for the fund increased by $294 million. As we move into the third quarter, ADX declared a distribution on July 18 of $0.05 per share from net investment this distribution will be paid on August 30 to shareholders of record on August 16. This represents a third payment this year toward the fund annual 6% minimum distribution rate commitment.That concludes our prepared remarks. We would now like to begin the Q&A portion of our call, operator.

[Operator:]

We will now begin the question-and-answer session [Operator instructions]

[Lyn Walther:]

Okay our first question regarding healthcare, how are you positioning your healthcare holding, given the political environment and the potential for Medicare for all?

[Mark Stoeckle:]

It’s a really good question and frankly a timely question. As I mentioned previously, we have been underwent biotechnology and Pharma for quite some time now, and the real reason for that is the difficult political environment, as you know. I’m sorry, we have also been underwent managed care and that really speak to the issues around Medicare for all as some people who are running - some candidates running for President would like to get rid of all managed care companies, all the insurance companies.It’s something that we keep a careful eye on. It’s very clear to us that there were going to be a pretty substantial headwinds on pricing, which seems to be pretty by part both democrats and republicans are keenly interested in reducing drug pricing.So we have as I mentioned been underwent Biotech and pharma and as I mentioned in my prepared remarks it certainly benefited the fund. The fact that we are underwent both and the stock that we owned in them, in those industry groups were standouts really significant help performance.So it's something we keep a careful eye on, at some point biotechnology is going to get too cheap and we will look to get back in, pharma will get to cheap, but for now it’s something that we feel very comfortable with the underwent and Biotech pharma and managed care.

[Lyn Walther:]

Okay thanks for that. Our next question, you mentioned technology, healthcare and consumer staples as standout are there any other sector that perform particularly well in the first half of the year.

[Mark Stoeckle:]

I think it's important to point out the material sector. Materials is actually less than 3% of the S&P 500 weight, but it contributed a significant amount to the fund's returns in the first half and that really was a result of owning the two best performing stocks in materials, Ball Corp which was up 53% and air products, industrial gas company up 43%.The term we use around here is material to significantly punched above its weight, because it is so small but the benefit to the fund from such a small sector doesn’t happen very often which is really a good reason to call out how well its done.

[Lyn Walther:]

Okay the next one is regarding energy. Oil prices has been fairly volatile this year, how has the energy sector performed?

[Mark Stoeckle:]

The S&P energy sector was up 13.1% and so it underperformed the S&P 500. About 40% of our energy exposure comes from Adams natural resources fund and that was up 13.9% for the period. So we were to perform outperform energy, the performance was helped in a pretty significant way by an M&A transactions that happened in the sector.Anadarko Petroleum was approached by Chevron to be acquired, and after that happen occidental petroleum came in and Trump there be at much really took Anadarko stock price up significantly. So we benefited lot by that.We were really troubled by the extent to which , occidental when to get the company, happy about the, what it did the Anadarko, we were really troubled by the extent to which occidental to get the company, to get Anadarko.They outbid, respectively outbid themselves to Chevron only been once. Number two they went to Berkshire Hathaway and got what we thought was very expensive financing for the transaction and number three it wasn’t really clear to us, the addition of Anadarko what that was going to do for us.So we significantly reduced our exposure to Occidental just after the it was clear that Chevron was not going to bid for the company and one of the smartest things we did in the quarter was to reduce our exposure to Occidental because it significantly underperformed after we sold it.So we were able to benefit a couple of ways. With the energy its tough you mentioned the volatility, you asked the question it has been very vital and we are often asked what is it going to take for energy to turn around.I can tell you from an investors standpoint for probably the last five years or so it has been a systematic adding of value by not being in energy. So it is really paid to ignore energy because its underperformed by so much.And I will give you a little statistics in 2008 energy represented about 13.4% of the S&P 500. Today it represents less than 5 and you have seen significant value being destroyed and by the way that is 5%, less than 5% is you have to go back for the year 2000 in order to find a period when energy represents such a small percentage of S&P 500.So in some respects from an investors standpoint you don’t have to be an energy, you can ignore because it’s so small. We do think that capital discipline and showing free cash flow it’s something that a lot of these companies energy companies have to begin to do in order to get people interested.Because effectively what they are doing is energy stocks are competing with healthcare stocks, with technology stocks and bunch of other sectors that are really continuing to do well generating a lot of free cash flow. So I think we need to get there in order for technology to significantly turn around.

[Brian Hook:]

Operator would you remind our participants the Q&A instructions again please.

[Operator:]

[Operator Instructions]

[Lyn Walther:]

Okay along these lines, there has been an increase in M&A activity this year and concern over how some of these deals were structured. You mentioned Occidental and Anadarko in energy. In healthcare AbbVie agreed to buy Allergan. What are your thoughts on how these transactions were handled?

[Mark Stoeckle:]

I mean I will tell you and I think this is a pretty important point, because I believe in both cases Occidental and AbbVie showed very, very poor judgment in corporate governance. Both transactions were specifically structured so as to eliminate the need to go to shareholders to approve a transaction.Now if this was a routine matter, it really wouldn’t matter, but these were both are both transformative transactions that I think it's imperative that the shareholders have the ability to weigh in on them. These triggers were put in there bylaws for specific reasons.I mean it have the specifically said they will issue stock up to 19.9% of the outstanding when the triggers 20 to go to shareholders. So to me it was a blatant disregard for good corporate governance and it surprises me a little bit that more hasn’t been made of it whether its French or broadcast journalists that does surprise me, but it’s something that is troublesome from an investor standpoint, we believe.

[Lyn Walther:]

Okay we received this question through a website recently from a shareholder in Thailand. I have been a holder of ADX for more than 15 years and so is my grandson who probably own 200 shares. Several years ago you received stockholder approval to run on the side of managed portfolio for a single large client, do you still have only one client or how you additional clients how is that side business doing?

[Mark Stoeckle:]

First, a couple of things, one a shareholders in Thailand is pretty cool, we will have to say. Second, weappreciate your confidence in us, it's nice to have long-term shareholders like you and we will continue to do our best for your grandson.The transaction or the relationship that we had with the company called Union Bancaire Privee and we were running a U.S. small-cap fund for them. We had relationships with some of the UPB folks when I was at BNP before I got here and they had asked us to run a U.S, small-cap fund, which we did.The reality is in Europe where they were distributing the fund, there is almost no interest or demand for U.S. small-cap, they try very hard to sell the product and it wasn't something that was able to be sold. So from a corporate stand point, they made the decision to close the fund and merge it with their U.S. growth fund, it has a lot more demand from European investors.So we do not have that client anymore, we do still have the business open in case we are able to identify someone else that would like us to sub advise a funds for them, but as of right now there is no clients and no fund being run.

[Lyn Walther:]

Okay our next question is on our technology holding. Would there be a continuity, continued percentage of high growth securities such as Netflix, Facebook et cetera, and will there be some shift towards valuing. I think the concern is whether or not with the political sector as we get closer to 2020 will that have a material impact on the portfolio?

[Mark Stoeckle:]

It’s a good question especially in light the DJO announcing yesterday they were going to go after some of these companies. There are couple of things first, we are well aware, as I know many of you are that growth has significantly outperformed value now for years.And I will tell you that it is a topic of discussion at every single one of our portfolio management meetings, because we do know at some point that is going to stop, it will not continue forever. So we are very sensitive to that issue.I think it's important to know that when you talk about the traditional FANG stocks you know Facebook, Amazon, Netflix and Google. We today are underweight them compared to where we were a couple years ago, and part of the reason for that is the business models have gotten more challenged, there is a little bit of evaluation issue as well.That the business models are little bit more challenged, we still own bit all of them, but we are underweight as you can see by our filings, we are underweight Facebook, we are underweight Google. And it's something that we think is the right thing to do, especially companies like Google.The law of large numbers you can only grow it 20% for so long and its one of the issues that Google is having right now. They will report tomorrow night and we will see how they have been able to do, but it's really important for the portfolio management team of ADX that our investors know we are aware of the issues revolve around these companies.Netflix, we do own some Netflix it’s a very, very small position and so it really is not - even a wiggle in Netflix is not going to significantly upset the Apple cart as far as performance, but we are well aware of the challenges that some of these high growth stocks have.And I think one of the things that we have been good at, we are good at many things, but one of them is as stocks do really, really well and we can take Microsoft as an example. Microsoft has done very well, Chipotle had done very well.So these stocks that we own, as they have continue to do really well, we will pair back our ownership of them. And it’s really a risk control mechanism. Some funds you will see they will let their winners run and they will end up - Chipotle would end up being 5% or 6% of the fund that to us is way too much risk.So when we have stock that do exceptionally well within each sector we have been very good at beginning to pair them back to take a careful eye toward risk and make sure that were not leaving the fund out over the risk spectrum too much.

[Lyn Walther:]

What is your outlook for the market, how are you positioning the fund, given that we are in the 10th year of this full market?

[Mark Stoeckle:]

We are bit cautious, I will say as I said earlier trade is really issue, companies are - especially as it relates to capital expenditures companies are taking a wait and see attitude because they don't know which way trade is going to go.I mean we have all watch the news and read the papers and it seems to change every week, the trade negotiations is going well, they are not going well, we should have something soon, we are don’t have anything at anytime soon.So it’s really been difficult and I think it’s starting to show in management teams sort of pulling back and waiting to see how things shake out before they commit serious capital expenditure dollars. So it is something that we think is a real issue and we are cognizant of.The second is the fact that - we talk about a 10 year bull market, we don’t really look at it as the 10 year bull market. We look at it as - it’s certainly been good, but we are not good enough to know when that is going to end. But what we do think we are really good at is identifying companies that are doing good things operationally at good prices.So we believe if unless there is a very fast change from growth to value or the bull market stops in its tracks pretty quickly. We believe that we should be able to navigate a change out of real bull market pretty well and it really ends up being just executing our process the way we have always executed it.We are not growth managers, we are not value managers, we are really good at stock selection and we will continue to do that regardless of whether the bull market continues or doesn’t.

[Lyn Walther:]

Okay I think that is all the questions we have today. Mark, do you have any closing comments?

[Mark Stoeckle:]

I do, I really want to acknowledge what I think is a very talented team that we have here at Adams. We have an experienced group of industry analyst, we have experienced portfolio managers that have been working there for quite a long time, which are all supported by strong infrastructure and accounting and compliance. We are a team that takes a long-term view and incorporate a disciplined approach to investing.I do want to thank our shareholders from investing with us, we do appreciate your trust in us and do not take it for granted. We do intend to keep earning it by maintaining our focus on delivering consistent investment returns for you. For that we thank you.

[Lyn Walther:]

Alright, thank you all for joining us today. We look forward to updating you on our performance in January.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.