Q4 Commentary (2007)
| ANNUALIZED RETURNS | ||||||
|---|---|---|---|---|---|---|
YTD |
TRAILING |
|||||
| 4Q07 | 2007 |
3 YEAR |
5 YEAR |
|||
| Taxable Composite* | -3.7% |
5.5% |
6.8% |
11.5% |
||
| Tax-Exempt Composite* | -4.2% |
4.8% |
6.9% |
11.7% |
||
| S & P 500 Index | -0.7% |
5.5% |
8.6% |
12.8% |
||
| *net of fees | ||||||
January 9, 2008
Looking back on 2007, two of the better performing sectors for us were our consumer staples and energy. Companies held throughout the entire year that produced a total rate of return greater than 15% included Altria (Philip Morris) Avon, Chevron, Colgate, Conoco Phillips, CVS/Caremark, Coca Cola, Royal Dutch and Wrigley. Two new holdings this year that performed nicely included Aflac (up 20% since our purchase) and Procter & Gamble (up close to 20% since purchase). Kaydon, which we have held since inception of our firm posted another great year, up well over 30%. So with all those wonderful returns, why did we not do better? We believe that short term investor fears artificially depressed the valuations for a number of our holdings and as a long term
investor, we remain confident in the long term outlooks for these companies. Consider Cintas, Home Depot and Sherwin Williams as examples of economically sensitive holdings that were all down for the year, despite their strong fundamentals and longer term prospects.
| 12/31/07 | 12/07e | 12/08e | 2007 | 2008 | 2007 | 2008e | |
|---|---|---|---|---|---|---|---|
PRICE |
EPS |
EPS |
P/E |
P/E |
DPS |
DPS |
|
| CINTAS | $34 |
$2.09 |
$2.35 |
16.2X |
14.5X |
$0.39 |
$0.45 |
| HOME DEPOT | $27 |
$2.35 |
$2.70 |
11.5X |
10.0X |
$0.90 |
$1.00 |
| SHERWIN WILLIAMS | $58 |
$4.70 |
$5.25 |
12.3X |
11.0X |
$1.26 |
$1.42 |
Each of these companies faced a real operating headwind in 2007. The housing market impacted both Home Depot and Sherwin Williams. Cintas, which is a new holding this year, has completed a sales force reorganization and this effort should reap the benefits beginning in 2008. We believe the Street is very much underestimating the quality of this management and their vision. As for Home Depot, they were the most effected by the housing slowdown, but like Cintas, management has taken decisive actions to improve comp store sales, improve employee morale and retention and return to their historic path of consistent earnings growth. We like the plan and believe they have the resources to succeed. Sherwin is an enigma in that it continues to deliver exceptional returns, while improving its overall global competitive position. Investors are missing the fact that 80% of paint sales go into existing homes, which explains why they were able to maintain their earnings growth last year, while others that are exposed to new homes were hurt. All of these companies are attractively priced and they should be positive contributors to performance in 2008 and beyond.
Part of our research process involves the establishment of a “position paper” for each of our investments. This paper details specific operating and financial metrics that we expect the company to achieve in the foreseeable future. When companies are not achieving the desired metrics and can not fully explain the shortfall, we sell them. We had two such experiences in 2007 with Foot Locker and MBIA. These two holdings also hurt returns for 2007.
Year end letters afford us the opportunity to not only review the most recent year, but to put that year in perspective of longer term results. Since our founding in 1999, the markets have undergone two distinct periods of performance. The first was the three year bear market of 2000 to 2002 and then for the next five years, the markets have moved solidly higher. Philosophically, Coho Partners seeks to preserve principal during the down periods, while remaining competitive during the advancing times. Bifurcating the most recent eight years into the down phase of 2000 to 2002 and the up phase of 2003 through 2007, we believe we have delivered well against our pledge.
| TOTAL RETURN | TOTAL RETURN | TOTAL ANNUALIZED RETURN | |
|---|---|---|---|
2000-2002 |
2003-2007 |
2000-2007 |
|
| Coho Taxable Composite (net) | -0.4% |
72.7% |
7.0% |
| S & P 500 Index | -37.6% |
82.8% |
1.6% |
We believe this asymmetrical pattern of results can be achieved in the future by rigorously adhering to our disciplines and systems. By pairing advantaged sectors with advantaged characteristics, Coho Partners increases the likelihood of outperforming during the difficult times and still can remain competitive in the rising markets. Since inception, we have built a portfolio that is overweighted in consumer staples, healthcare and integrated energy companies because these defensive sectors hold up particularly well during stressful periods. Characteristically, our portfolio has always had an above average dividend yield and better than market dividend growth. The portfolio’s P/E has been equal to or less than that of the market on both a current or prospective basis and yet the earnings growth rate has consistently been faster than that of the market. Beyond that, the companies in which we invest have well articulated operating and financial strategies, they are very profitable and they tend to be not overly capital intensive.
These factors are present all the time. Although we do not yet know the 4th quarter results, we believe that all but two of our current holdings will show positive growth in earnings per share this year and all but two of our holdings will have increased their dividend at least once in 2007. The average dividend increase was in the mid teens, consistent with the past few years as well. Such generous dividend increases are a hallmark of our portfolios and we expect another year of double digit growth in dividends in 2008.
Finally, as a sign of further financial strength and confidence in the future of these companies, all but two of these companies reduced their outstanding share count by Board approved share repurchase programs. We support the tactical use of share repurchase because we believe it improves shareholder returns over the long term.
We enter 2008 in a conservative position. The portfolio has a fair bit of cash, which is a byproduct of some modest reductions in certain holdings because of valuation and the elimination of MBIA. We believe that better buying opportunities will arise in 2008 that will allow us to redeploy this cash into unappreciated, high quality companies.
We hope that you had a relaxing and enjoyable holiday season with friends and family and we wish you all the best in your new year endeavors.Sincerely,
Peter A. Thompson
