I have only a few clients with Brandywine funds left. I began pairing back on Brandywine as a core holding in 1993. I have felt for years that there are better offerings in the Large Cap arena. As my clients know, I don't sell a fund unless they no longer wish to hold it hence not everyone has the same holdings. Litman Gregory and Morningstar are fans of Brandywine funds and have recommended them for years.
For my client's that still have Brandywine in your portfolio, here is an update by Litman Gregory Analytics regarding two Brandywine funds:
Brandywine (BRWIX) and Brandywine Blue (BLUEX)
Category: Larger-Cap Growth
Manager: Bill D’Alonzo
Date of Interview: 11/07/06
With: Trey Oglesby, Scott Gates, Fran Okoniewski, James Gowen, and Ward Jones (research analysts)
On a recent trip to the East Coast, we visited Friess Associates (advisor to Brandywine Funds) in their Greenville, Delaware, offices. The objective of our visit was ongoing due diligence, where we continue to test our original thesis for recommending a manager. The majority of our time was spent with members of the firm’s research team where we had in-depth stock discussions in order to assess the consistency with which the team follows its investment discipline. The Friess approach centers on identifying catalysts that will enable companies to deliver stronger earnings than Wall Street expects. Determining which companies will beat consensus estimates is accomplished through numerous conversations with company managements, competitors, customers, and suppliers, which Friess refers to as “trade checks.” Below are some details of these stock discussions.
Dick’s Sporting Goods, a retailer of name-brand sports apparel, footwear, and equipment, was brought to Oglesby’s attention by a sell-side analyst who noticed increasing sales for the company. Oglesby started his research process by obtaining a Wall Street earnings model in order to understand Wall Street’s growth assumptions for the company. Then, he began trade-checking the company to see if there are catalysts that could lead to better-than-expected earnings. Oglesby says one of the most relevant factors behind Dick’s improving revenues is strong sales of Under Armour products, a maker of performance athletic apparel. Providing perspective, Oglesby says Dick’s sales of Under Armour are growing 60%, while camping equipment sales are growing 3%. So in order to understand Dick’s earnings potential, “We had to stay on top of Under Armour,” says Oglesby. Calls to Under Armour’s management, as well as other makers of performance sports apparel, revealed strong demand for these products. Oglesby confirmed this demand through a third-party source who surveyed customers’ interest for these products. Meanwhile, conversations with Dick’s management revealed plans to devote more floor space to this apparel, something Oglesby suspects may not be fully factored into Dick’s sales estimates.
Another potential source of positive earnings surprise is Dick’s integration of Galyan’s Trading Company, which was acquired in 2004. Oglesby explains that up until now, Dick’s hadn’t included these former Galyan’s stores in their store-base count because they needed to be converted into Dick’s store format. Oglesby says this integration has taken a long time and has been a headwind for the stock, but based on his trade checks, the feedback for these new stores is “very, very positive.” He believes the success of these additional stores will lead to better-than-expected year-over-year earnings comparisons. The Galyan’s acquisition aside, Oglesby says Dick’s square-footage growth, a key driver in retail, is going very well as the company continues to effectively expand its store base.
Given Dick’s organic growth, along with stronger-than-anticipated sales of Under Armour products, and the successful integration of Galyan’s, Oglesby is confident that Wall Street’s sales projections are conservative (although he did not provide his actual earnings estimate). As part of assessing whether Dick’s can surprise on the upside, Oglesby ran through a sensitivity analysis to understand how increasing costs of Under Armour products, for example, would impact Dick’s profitability. In the end, Oglesby’s earnings estimates are at least 10 cents higher than the $1.98 consensus earnings for the company’s fiscal year. He also believes there’s room for multiple-expansion. Oglesby says Dick’s P/E multiple is roughly in line with similar retailers but he thinks the company’s higher-than-average growth warrants a slightly higher premium. The main risk Oglesby sees is declining consumer spending. However, he says trade checks throughout the retail industry suggest that consumers are still spending.
Carpenter Technology is a stock we discussed in our last fund update, but has since been sold. The company is a producer of high-quality specialty steels that are used across various industries including aerospace, health care, and industrial machinery. A big part of Okoniewski’s investment thesis was the company’s decision to refocus its business on higher-margin specialty metals (particularly to the aerospace industry), and de-emphasizing lower-margin products. Okoniewski says management is executing, and revenues from the aerospace division—which were growing at approximately 20% when Friess purchased the stock—are now growing at almost 40%, while aerospace operating profits as a percentage of total profits have gone from 35% to almost 80%. Meanwhile, Carpenter reported one of its most-profitable quarters, beating Wall Street consensus earnings estimates by $0.50. Looking ahead, Okoniewski expects continuing demand for Carpenter’s specialty metals as the airline industry is increasingly focused on making lighter, more fuel-efficient aircraft.
Although Okoniewski believes Carpenter’s operations remain solid, and demand remains strong, he had to sell. He says that after Carpenter’s strong quarterly results, Wall Street expectations became very aggressive as analysts seemed to extrapolate recent results into future quarters. Wall Street estimates exceeded Friess’ estimates by 15% to 20%. Friess only owns stocks where it sees the potential for upside earnings surprise, and as such the stock was sold.
Fischer Scientific, a distributor of scientific equipment, chemicals, and supplies, is a long-time holding. The company is in the process of merging with Thermo Electron, a maker of high-end analytical instruments and laboratory equipment. Gates believes there are a number of reasons to be excited about this combined company. Generally speaking, Gates believes managements are often conservative when it comes to estimating post-merger cost savings. “Most managers just lop 10% off overhead because of merger synergies,” says Gates, but in this case he believes this is extremely conservative. “When I work through the model with both managements, and look at prior acquisitions [there have been probably 30 in the last five years], not one acquisition have they realized less than 10%,” adds Gates. A potential downside is integration risk, as this is the biggest merger for both companies, but Gates isn’t giving it much weight. His confidence is based on the historically acquisitive nature of both companies and his long history with both companies.
Trade checks have revealed that customers are excited by the merger. Gates met with companies that are planning to begin distributing their instrumentation through Fischer, because of the worldwide distribution they gain through the merger. “These contacts go a long way in giving you confidence in what you think management can do,” says Gates. Gates believes Wall Street will eventually see past the “danger zone” and give the company full credit for the power of this merger. “It’s just a matter of proving they can bring the two companies together,” says Gates. As for existing customers, Gates spoke to heads of buying for Astra Zeneca, Bristol-Myers, Lilly, and Pfizer, all of which like that they’ll be able to do one-stop shopping once the companies merge.
Gates is conservatively estimating earnings of $2.50 for 2007, compared to the company’s guidance of between $2.27 and $2.38. On top of higher-than-expected cost savings from the merger, Gates says, “I expect management to make more accretive acquisitions, which could further boost earnings.” When picking a multiple to put on earnings, Gates says the company is growing 30% but he’s applying a 20x multiple, which results in a $60 price target. At the time of our interview, the stock traded at $48. “I think there’s upside in the multiple, and as management executes, Wall Street will give it a better multiple. It will come and I don’t need to raise my multiple now,” says Gates.
Litman/Gregory Opinion
Both Brandywine and Brandywine Blue are having good years. Investors should note that when evaluating Brandywine Fund’s performance, we find it is useful to look at several benchmarks in light of the fund’s all-cap flexibility. We think the best long-term benchmark is the Russell 3000 Growth iShares, but since it is not a perfect fit we also look at the Russell 1000 Growth iShares (a large-cap index), the Russell Midcap Growth iShares, and the Russell 2500 Growth (a mid/large-cap index), to help us get a good overall gauge of performance. Brandywine (up 10.7% so far in 2006) is handily beating the Russell 3000 Growth and Russell 1000 Growth iShares, which are up 8.9% and 8.5%, respectively. Brandywine Blue (up 10.9%) is well ahead of the Russell 1000 Growth iShares.
Looking at longer-term performance on a calendar-year basis going back to the mid-1980s the team has an excellent record except 2002, and 1997 to 1998, which we discussed at length in our June 2001 due diligence report. As we have said before, the Brandywine Fund was one of the few growth funds to capture a lot of the upswing in 1999 and still have a positive return in 2000. The fund’s risk (as measured by standard deviation) is higher than the benchmark’s, but we think the fund’s greater exposure to smaller-cap stocks explains most of the added volatility.
Based on our recent discussions with the analysts, it remains clear that the team is obsessive and thorough when it comes to conducting industry trade checks. They talk to companies up and down the food chain, and across sectors and industries to help them uncover good ideas and gain an information edge over the competition. We view the team’s emphasis on this practice as the most important aspect of its success. On top of this there are several other positives. There is a clear consistency of philosophy across the team. All of the analysts we’ve spoken to seem to completely buy into the approach and are consistent in their understanding and application of the process. Additionally, there is a major emphasis on productivity, where the goal is to keep the research team focused only on stock picking and maximizing productivity. Another positive is stability. Senior team members have long-term employment contracts and have laid out succession plans. Friess has continued to dole out equity to the investment team members as well as non-investment team members, fostering continuity and reducing the chances of personnel turnover.
We do not have any major concerns at this time and both funds remain on our Recommended list of larger-cap growth funds. We have a minor concern related to the future growth of the firm’s asset base and how it will potentially impact the team’s ability to successfully execute their process. For now, asset levels (total firm assets are about $9 billion) are reasonable and we are confident the funds can continue to beat their benchmarks going forward.
Although Brandywine Fund is more difficult to pin down from an asset-allocation standpoint, we think it is still a suitable larger-cap option. Investors who are seeking more dedicated large-cap (but not mega-cap) exposure should consider Brandywine Blue.
—Jack Chee
__________________________________________________________________________Reprinted from AdvisorIntelligence. Copyright© 2007 Litman/Gregory Analytics, LLC.
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