Q2 Commentary (2008)
| ANNUALIZED RETURNS FOR PERIOD ENDING 06/30/08 | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2Q08 | YTD | 1 YEAR |
3 YEAR |
5 YEAR |
INCEPTION TO DATE VS. S&P 500** |
|||
| Coho Tax-Exempt Composite* | .1% |
-5.0% | -6.8% |
5.7%/yr. |
8.9%/yr. |
6.4%/yr. vs. 0.2%/yr. |
||
| CohoTaxable Composite* | .6% |
-4.8% | -6.0% |
5.9%/yr. |
9.0%/yr. |
6.0%/yr. vs. 0.0%/yr. |
||
| S & P 500 Index | -2.7% |
-12.0% | -13.2% |
4.4% |
7.6%/yr. |
|||
*net of fees |
||||||||
July 7, 2008
Dear Friends of Coho Partners Ltd,
Leading into the month of June, the market had enjoyed two strong months in April and May which had almost completely offset the broad decline in the first quarter. However, as you are probably aware, June was a particularly difficult month, which negated more than all of the benefits from the prior two months.
Despite June’s swoon, the pattern of our results this quarter and year to date have been consistent with our philosophy of preserving principal during the down periods and staying competitive during the advancing times. In the quarter, we actually outperformed during the April/May period, and we fell less than the market in June. We were disappointed that we did not provide even more protection in June, but the sell off was so large and broad based that few were spared. Linking all the monthly returns, we were able to comfortably beat the S&P 500, but were disappointed by the absolute return.
Year to date, we would echo those same sentiments, which is to say, our relative performance is quite good, but the absolute return is not helping anyone.
We have been remarking about the following macro pressures, all of which are eroding the spending power of the consumer and reducing his confidence. To summarize some of the more important issues, they are:
- Dramatically rising energy and food prices
- Falling housing and stock market prices
- A weakening employment outlook
- Tighter credit and higher mortgage rates, which continue to delay any hope of a housing turnaround
- Large and continuing write offs for many financial concerns
With all these headwinds, we are carefully assessing the impact to the earnings power of all of our holdings. The vast majority of our positions are consumer staples companies, healthcare companies and integrated oils. Even these reasonably “demand defensive” sectors are not impervious to the above mentioned factors, but we believe depressed valuations at present prices more than discount those headwinds. To a lesser degree, we are invested in a number of niche “economically sensitive” companies and here the analysis of the impact and duration of these headwinds is trickier. We like those valuations as well, but we fully understand that during times like this, valuations can move to extremes and we want to be very selective in adding to this area.
As we look back over our inception to date performance, we note that we have experienced two very different down periods through which we have been able to deliver strong relative results. We attribute these results to our philosophy and disciplines. The challenging period from 2000 through 2002 was a “growth” bear market, with the majority of the pain being felt in technology holdings. This period was particularly difficult for growth managers. Over that period, the S&P 500 fell by nearly 38% and we retained almost all of our principal. The most recent downturn, which began in the 4th quarter of 2007 has been much more of a “value” bear market, with the brunt of this decline occurring in the financial sector. Many well known value managers have had a very trying time over the past few quarters. Over this downturn, we have avoided about half of the decline, which is not as good as we would like, but the downturn may not be over yet.
As truly long term investors, we full expect our turnover to remain very low, but during times like this, opportunities can arise where we can beneficially “upgrade” the portfolio. Indeed, as the market declined throughout the month, valuations improved for a number of companies that we had been watching for possible inclusion to the portfolio. At the end of the month, we monetized our Wrigley investment at a price close to the $80 Mars offer price and used some of the proceeds to initiate a position in Smuckers, a wonderful niche food company. This decision was predicated on increasing the overall return potential of the portfolio, while lowering risk and improving the overall portfolio characteristics.
Looking to the second half of this year, it will be critical to keep the portfolio fundamentally rooted in companies that are able to produce consistent earnings, grow their dividends and use their strong balance sheets to improve their competitive position when others can not.
Most of the market, with the exception of the direct commodity and energy plays, is struggling with slowing top lines and increasing cost pressures negatively impacting their bottom lines. Our holdings face the same pressures; nevertheless, we expect the vast majority of our companies to post higher earnings in 2008 than they did in 2007. In addition, approximately 75% of our holdings have already increased their dividend in 2008 and we fully anticipate that the remaining holdings will do so by year end. Finally, because of the relative strength of their balance sheets and consistency of their cash flows, many of our companies are taking advantage of the downturn to press their advantage against their weaker and less flexible competitors. While the benefit from these initiatives may not manifest until the economy recovers, it is another reason we like holding the hand we have during the tougher times.
As we work our way through this economic downturn, the portfolio characteristics that have historically helped us achieve our pattern of results of downside protection and upside participation remain in place. That is to say, the overall portfolio yield is higher than that of the S&P 500 and the dividend growth is generous. The overall P/E is equal to or less than the S&P 500 when measured against 2008 or 2009 expected earnings. Our companies have intrinsically high profit margins and they are not overly capital intensive. The consequence of this is that they generate quite a bit of excess cash flow, which tends to be used to optimize shareholder value, either via share repurchase, or niche deals that improve their long term business outlook.
Candidly, while June was considerably more painful than we would have expected, we remain encouraged about the long term outlooks for our companies.
Wishing you all the best in your summer endeavors.
Sincerely,
Peter A. Thompson
