18 Oct 2012 Thornburg Value Fund - Q3 2012 Commentary ( Portfolio )
Portfolio performance for the Thornburg Value Fund for the third quarter of 2012 was favorable. For the three-month period ended September 30, 2012, the fund returned 6.92% (for the A shares, without sales charge) versus 6.35% for the benchmark S&P 500 Index.

Aggressive central bank actions around the world have put to rest some of the dramatic downside scenarios that weighed heavily on many stocks and indeed, on some names in the portfolio. We do believe that markets are still operating within a risk-on/risk-off environment (as discussed in this column last quarter), but for now at least, equity markets seem reassured by the policy actions being taken. Growth in the United States in 2012 has been lackluster, though recent indicators have come in above prior expectations. This appears to have given some investors hope that stronger housing prices, central bank actions, and low mortgage rates will benefit the American economy meaningfully.

Recall that a hallmark of Thornburg’s equity diversification approach is our classification of companies within a three-basket construct: basic values, consistent earners, and emerging franchises. Over the course of the last several months, we have worked to bolster the consistent earner aspects of the portfolio through the addition of names with more predictable business models. Previously, the portfolio had seemed to pack a greater basic value punch than is appropriate in the uncertain investment climate we face. In short, we are executing on our core philosophy and working to ensure that we have a portfolio that has the opportunity to outperform in any market environment.

Positive Contributors to Performance for the Quarter

Long-time holding Gilead Sciences, Inc. is finally proving a rewarding holding. The stock has risen to a roughly 18x earnings this year, as other investors seem to be catching on to the revenue potential of its “Quad” HIV regimen (which we have been excited about for some time) and to its Hepatitis C treatment pipeline. A number of analysts have increased their earnings estimates in the “out years” to over $10 per share (for years 2016 and 2017), which supports additional stock price appreciation from this point forward.

As online advertising trends continue to develop positively, Google, Inc. continues to perform well. Global online marketing market growth may accelerate. We note that for the first time, TV viewership statistics (as reported by Nielsen) are deteriorating, and advertiser thinking appears to be shifting with the increasingly convincing online advertising arguments.

Gap Inc. has rebounded this year: online revenue has grown rapidly and store performance has improved. Comparable-store sales increases have been in the double digits recently, and we believe there remains upside in the stock price, though we have trimmed our position somewhat.

ThermoFisher Scientific’s price had been depressed with speculation surrounding the potential effects on the company’s order base of the looming fiscal cliff, but investors now seem more comfortable that these effects might be limited, and the stock has rebounded. ThermoFisher is a strong consistent earner company that has grown revenues at approximately 15% per year.

Apple, Inc. saw a relatively weak quarter coming into the launch of the iPhone 5, but we believe the company will continue to gain share in the smart phone market. The company is behaving very assertively with product development, with a new iPad mini announcement expected this month.

Detractors from Performance for the Quarter

We have recently performed a healthy amount of analytical work on the portfolio’s steel industry holdings, especially as they pertain to potential GDP growth deceleration in China and the moribund demand from Europe. One of those firms, Tokyo Steel Manufacturing Co., suffers from depressed prices and market concerns over a so-called Chinese hard landing. Despite the firm’s pristine balance sheet, lack of pension liability, and its flexible business model, its new plant is operating at a fraction of capacity. The company, along with other steel manufacturers, has been caught in a general downturn. But we believe Tokyo Steel can weather the storm better than its competition, and that a recovery is likely.

Secular challenges in the office supply industry have had a greater impact on demand for Staples’ products than many analysts predicted, ourselves included. Businesses are behaving far more conservatively in their office spending, and brick-and-mortar retailers face increased competition from the electronic delivery channel. Consistent with our efforts to track tightly with our investment theses, we have sold the position.

Genworth Financial is a leveraged play on global growth, and in particular, on the mortgage insurance business in the United States, Canada, and Australia. The company’s life insurance segments benefit from high-rate, steep yield-curve environments and suffer when the reverse is the case. Given the potential outlook for rates worldwide and lackluster mortgage markets, we concluded the company is no longer a good fit for the portfolio and sold the position.

From an analytical perspective, Best Buy Inc. has been a difficult holding — and one that pressured performance during the quarter. We liked the company’s smartphone business. We believed a cyclical rebound would help earnings. We were, in certain ways, comfortable with the company’s stores being showrooms for online shoppers. But when TV manufacturers implemented so-called unified pricing policies (equivalent pricing online and in physical stores), the result was the opposite of what we expected: Best Buy was unable to discount and drive traffic, and sales declined. This competitive weakness led us to conclude the firm is at a greater disadvantage versus other channels than we realized, and we sold the position.

Intel’s performance for the quarter was weak, as strong sales of tablet computers, a segment in which the company is relatively weak, have surprised many analysts and appear to have eaten into conventional laptop sales, an area in which the company is better positioned.

Notable Sales and Purchases During the Period

Note that of the most significant detractors from performance for the period, several (Staples, Inc., Genworth Financial, and Best Buy Co.) have been removed from the portfolio. This reflects efforts to track tightly to our investment theses and move out of positions, when warranted, via a disciplined approach. Other sales during the period included Yahoo! Inc., which has suffered chronic leadership issues, and Office Depot, whose performance was impacted by the same factors that drove Staples’ share price lower.

Notable purchases included Illumina, Inc., ConocoPhillips, Accenture plc, Amazon.com, and ADT Corp.

Illumina is a leading developer, manufacturer, and marketer of life science tools and integrated systems for large-scale analysis of genetic variation and function. It is the market leader with 90% share in the high-throughput next-generation sequencing market and greater than 60% in overall next-generation sequencing share.

We believe that over time, integrated oil company ConocoPhillips will invest in projects with double-digit return on capital potential and that they will return capital to shareholders through dividends and share repurchases.

Accenture is a management consulting, technology services, and outsourcing company with operations in more than 200 countries. Accenture will benefit from ongoing adoption of new technology in business enterprises; there is no other company in the world positioned to benefit from this secular growth in the same way.

Amazon.com is a leading e-commerce retailer benefiting from gradual share gain of e-commerce globally. We believe continued revenue growth of 25% to 35% is possible.

ADT is a leader in the home security industry with the most recognized brands and a 25% market share, while the number two player has only a 3% to 4% market share. We see notable total return opportunity in the stock over the next several years.

Conclusion

We invest in promising companies selling at a discount to their intrinsic values. Our focus remains on performing thorough, bottom-up analysis on a security-by-security basis. Though we have worked to bolster our consistent earner basket to assure market-appropriate diversification, most of our work is done at the individual security level. We are bottom-up stock pickers, focused on the fundamentals.