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 D’Artagnan Capital Fund
Williams College of Business
Xavier University
3800 Victory Parkway
Cincinnati, OH 45207-5162
Semi-Annual Report
March 31, 2011 – September 30, 2011
1 | X S E I F S e m i -­‐ A n n u a l R e p o r t TABLE OF CONTENTS
XSEIF Fund Manager Bios………………………………………………3
XSIF BEA Board Members………………………………………………6
Semi-Annual Performance Report……………………………………8
Fund Strategy………………………………………………………………..12
Fund Officer Roles…………………………………………………………13
Economic Report…………………………………………………………..14
Sector Reports
Consumer Discretionary…………………………………….17
Consumer Staples……………………………………………..25
Energy………………………………………………………………33
Financials………………………………………………………….40
Health Care……………………………………………………….47
Industrials…………………………………………………………54
Information Technology……………………………………..63
Materials…………………………………………………………..69
Telecommunication…………………………………………...74
Utilities……………………………………………………………..80
Current Holdings as of November 17, 2011……………………….…87 2 | D C F A n n u a l R e p o r t XSEIF FUND MANAGERS Ryan Alleman
Ryan Alleman is a senior Finance major from the Greater Cincinnati area. Within the fund, Ryan
is responsible for the Industrials sector. This past summer Ryan completed an internship in the
Purchasing Department of Toyota Motor Engineering & Manufacturing of North America.
Currently, Ryan serves as a student representative to the Advisory Committee of the University
Planning & Resourcing Council at Xavier, as well as Student Body President.
John Barber
John Barber is the Energy sector analyst, and is a senior Finance major from Springfield, KY.
John is a former intern of Fort Washington Investment Advisors in Cincinnati, and currently
works part-time at the O'Connor Sports Center at Xavier. He is also a board member of Xavier's
Alternative Breaks program, the 4pm Student Mass Coordinator, a volunteer mentor/tutor, and
enjoys playing intramural football and basketball at Xavier. Upon graduation in May 2012, John
plans to seek employment in corporate finance.
Ben Homan
Ben is a senior Finance major, graduating in December. He is responsible for analyzing the
Telecommunications and Information Technology sectors. When not at school, he enjoys going
to the gym and reading. After graduation, Ben is seeking a financial analyst position.
Nicholas Laborie
Nicolas Laborie is currently a second year utilities fund manager for the D’Artagnan Capital
Fund. He also works at Toyota Engineering & Manufacturing North America in the Risk
Management Group. He will be graduating in May of 2012 and will go full-time with Toyota in
June.
Steven Latos
Steve Latos is a Senior Finance Major/Information Technology minor from the Northwest
suburbs of Chicago, IL. As a member of the investment fund, Steve is one of two analysts in the
Consumer Staples sector. Currently, he is an intern for the River Hills Group at Merrill Lynch
Wealth Management after previously working as an intern for American Internet Services
Network in the summer of 2010. Out of the classroom, Steve is the Vice President of the Xavier
Club Golf team and a starting pitcher on the Xavier Club Baseball team. Upon graduation, Steve
is planning to start his career in investment banking.
3 | D C F A n n u a l R e p o r t Ben Lawrence
Ben is a senior Finance major from Indianapolis who oversees the Industrials sector. Ben is
currently the Chief Executive Officer for the D'Artagnan Capital Fund for the fall semester.
During the school year, he runs Track and Field while holding a part-time internship at
Valuation Research Corporation. Upon graduation, Ben will begin his career at Stout, Risiuous,
Ross as an analyst in their valuation and financial opinion group.
J. Curtis May
J. Curtis May is a senior Finance Major from Akron, Ohio. He oversees the information
technology sector for the Investment Fund. Curtis is currently interning with United Bank of
Switzerland and is also employed by the Applied Finance Department at Xavier as a Bloomberg
Research Analyst. Aside from the Fund, Curtis is the Treasurer for the Xavier University Men’s
Club Volleyball team, and is also a practice player for the Xavier Women’s basketball team.
Jaclyn O’Driscoll
Jaclyn is a senior Finance major with an Economics minor, who is from Los Angeles, CA. She
currently oversees the Healthcare sector. Jaclyn is the senior resident assistant in Buenger
Residence hall, and over the summer she interned at Merrill Lynch. She has previously interned
at Fifth Third in their Investment Advisors division as well. Last year she was Vice President of
the Financial Management Association and a member of the University Board for Scholarships
and Financial Aid.
Mathew Pastorcic
Matt Pastorcic is a junior Finance and Accounting major from Cleveland, Ohio. Matt is the
Consumer Discretionary Sector Analyst. Currently at Xavier, Matt is involved with his
professional business fraternity, Delta Sigma Pi and the Financial Management Association.
Last semester, he gained his first internship experience as a member of the accounting
department at Senco Brands. He plans on continuing to gain real-world experience next
semester when he will work as an audit intern at Deloitte. An interesting fact about him is that
his is fluent in Croatian.
Steven Rosenbaum
Steve Rosenbaum is a senior Finance Major/Information Technology Minor. From Oak Lawn,
Illinois, Steve is a Consumer Staple Analyst for the Investment Fund. Steve currently interns for
Raymond James Financial Services as the branch "client care specialist." He is also the
President of the Xavier Club Baseball team and a member of the Financial Management
Association. In his free time, Steve enjoys golfing, playing softball, watching the Chicago White
Sox, Green Bay Packers, and Xavier Basketball.
4 | D C F A n n u a l R e p o r t Joseph Simoneau
Joe Simoneau is a junior Finance major with a minor in economics. He is from Trumbull,
Connecticut and currently manages the financial sector of the investment fund. He interned over
the past summer with a finance and accounting firm back home and plans on interning in New
York City in the summer of 2012. He is a member of the Xavier S.T.A.R. club and helps write for
the Xavier Economics Magazine. In his free time, Joe likes to play soccer and watch football.
Daniel Strong
Dan Strong is a senior Finance major from Midland, MI. He is the Materials sector analyst for
the investment fund. Dan enjoys watching Xavier basketball and playing intramural floor
hockey. Upon graduation in May 2012 Dan plans to pursue a career in corporate finance.
Phillip Weickert
Phillip Weickert is currently a senior Finance major at Xavier University. He is one of the
Information Technology Sector Analyst. When he is not working on his finance coursework,
Phillip enjoys playing Basketball. He also is involved with many intramural sports, the FMA and
Beta Alpha Psi. In addition to his Finance major he is majoring in Accounting. He has been
successful in two internships in Public Accounting, where he worked busy season at Deloitte &
Touché, LLP as well as Grant Thornton, LLP.
Michael Krzan
Michael Krzan is a Junior pursuing a degree in Finance and Accounting. As a member of the
fund, Michael oversees the information technology sector. Originally from Columbus, he
returned to his hometown over the summer to complete an internship within the Credit Risk
Management arm of PNC Financial Services. Currently, Michael is the President of the Financial
Management Association and an Analyst Intern with Merrill Lynch Wealth Management. Mike
is scheduled to sit for the first level of the CFA in December. In his leisure time, Michael enjoys
playing competitive sports. He is the captain of his Intramural Flag Football team and a member
of the Xavier Boxing Club.
Joe Bauer
Joe Bauer is currently a junior Finance major with a Mathematics minor at Xavier University.
He is currently the materials sector analyst. Originally from Rochester, NY, Joe prides himself
on his loyalty, especially to Western New York Professional Sports teams, regardless of their
levels of success. When he is not working on his finance coursework, Joe enjoys playing Ice
Hockey. He is currently the treasurer of the Xavier Club Ice Hockey Team, and also serves as the
team captain. In addition, he serves on the Xavier Club Sports Council Peer Judicial Review
Board.
5 | D C F A n n u a l R e p o r t XAVIER FINANCE BOARD OF EXECUTIVE ADVISORS
November 2011
Maribeth Amyot
Vice President-Financial Administration
George A. Haddad
Xavier University
First Vice President-Wealth Management Advisor
Merrill Lynch
Mike Andriole
Senior Director
Tami Hendrickson
Emerging Markets Business Development
Vice President, Treasurer
Eli Lilly & Company
Federal Home Loan Bank of Cincinnati
Rebecca Hochstetler
Associate Director, Finance
North America Fabric Care Financial Analysis
The Procter & Gamble Company
Bill Hogan
Senior Vice President – Investments
American Money Management
J. Hunter Brown
Watson Wilkins & Brown LLC
John P. Horan
Vice President
Merrill Lynch
Jim Brugger
Director, Cash Management
Macy’s Inc.
R. Bryan Kroeger
Senior Vice President-Middle Market Lending
U.S. Bank, N.A.
John E. Callahan
Chicago Board of Trade
Thomas Lieser
Vice President – Investments
UBS Financial Services
Thomas M. Cooney
President
Cooney, Faulkner & Stevens, LLC
William Effler
Senior Vice President
American Money Management
James Eglseder
Investor Relations Manager
Fifth Third Bank
J. Douglas Gerstle
Assistant Treasurer, Global Treasury
Procter & Gamble
Brian Gilmartin
Portfolio Manager
Trinity Asset Management
Matthew D. McCormick
Vice President, Principal & Portfolio Manager
Bahl & Gaynor Investment Counsel
Nick C. Reilly
Portfolio Manager and Principal
Horan Capital Advisors
Kimberly Renners
Director of Wealth Management
OJM Group
Christopher M. Rowane, CFA
Senior Vice President & Senior Portfolio
Manager
Huntington Financial Advisors
6 | D C F A n n u a l R e p o r t James D. Schade
Senior Vice President
Merrill Lynch
Dora J. Vorherr
Director of Finance
Corporate Research and Development
The Procter & Gamble Company
Edward N. Waldvogel
Vice President – Capital Management
The Kroger Company
Kevin P. Whelan, CFA
Vice President and Portfolio Manager
Opus Capital Management
James Wilhelm, Jr.
Senior Portfolio Manager
Fort Washington Investment Advisors, Inc
Rebecca S. Wood
Managing Principal
Fund Evaluation Group, LLC
Patrick Sledz
Financial Advisor
Merrill Lynch
Special Advisor to D’Artagnan Capital Fund
7 | D C F A n n u a l R e p o r t SEMI-­‐ANNUAL PERFORMANCE REPORT By: Steven Rosenbaum and Matthew Pastorcic
Summary Statistics:
Statistic Total Return DCF Gross: -­‐12.49% Net: -­‐12.74% S&P 500 Gross: -­‐13.78% Sharpe Ratio -­‐0.086 -­‐0.102 Treynor Ratio -­‐0.125 -­‐0.146 Beta 1.07 6 Month M² 230 BP 6 Month Alpha 240 BP The above chart shows statistics for the D’Artagnan Capital Fund (DCF) from the period of
March 31st, 2011 – September 30th, 2011. The DCF returned a total gross return of -12.49%,
which is above the benchmark’s return of -13.78%. Given our exposure to total risk as measured
by the Sharpe Ratio and M squared, we outperformed the S&P500. Given our exposure to solely
systematic risk as measured by the Treynor Ratio and Alpha, we also outperformed the
benchmark. Our average beta during the 6 month period is 1.07, making us slightly more
volatile to changes in the overall market. Although the markets have done poorly and our beta
was higher than the overall market, the DCF still slightly outperformed the benchmark during
this time.
Statistic DCF S&P 500 Price/Earnings T12M 13.64 11.90 EV/EBITDA T12M 8.40 8.57 Dividend Yield 2.11 2.31 Expense Ratio .250% 6 Month Turnover 15.8% The above chart depicts common valuation ratios for both DCF and the S&P 500. Our trailing
twelve month P/E was slightly higher than our benchmark, while our trailing twelve month
EV/EBITDA and Dividend Yield were slightly below our benchmark. Although these ratios
serve their purpose as comparison measures, the DCF is an opportunities fund and invests in
undervalued large cap equities and not in an asset with any particular valuation ratio.
8 | X S E I F S e m i -­‐ A n n u a l R e p o r t DCF Investment Growth:
The above graph illustrates the investment growth of the DCF (measured in blue) and the IVV
Index (measured in red), which is a common ETF used to measure our S&P500 benchmark.
Both saw gains in the spring months and sustained heavy losses in the volatile and turbulent
summer months. Our DCF did slightly outperform the benchmark during this time.
Return Attribution:
Relative Weight to Benchmark + -­‐ -­‐ + + + + -­‐ + -­‐ + Sector Information Technology Consumer Staples Health Care Industrials Energy Financials Utilities Materials Telecommunication Services Consumer Discretionary Cash Total Excess Return Attribution Asset Allocation Return + -­‐ -­‐ + + -­‐ + + + -­‐ -­‐ -­‐0.28% Security Selection Return + -­‐ -­‐ -­‐ + + -­‐ -­‐ + -­‐ + 1.57% Total Excess Return + -­‐ -­‐ -­‐ + + -­‐ -­‐ + -­‐ + 9 | X S E I F S e m i -­‐ A n n u a l R e p o r t The above charts illustrate the amount of the DCF’s excess return over the S&P500 benchmark
that is caused from asset allocation and security selection. As an opportunities fund, our
strategy is to place money in securities with the largest mispricing, not in any particular sector
or industry. The DCF’s returns hold true to its strategy with 1.57% of its excess return coming
from security selection.
Style Analysis:
Style Analysis Sector Russell 1000 Value Index Russell 1000 Growth Index Portfolio Weights 46.28% 53.72% The above chart illustrates how DCF’s returns compare with the Russell 1000 Value Index and
the Russell 1000 Growth Index. As an opportunities fund, it is irrelevant whether our portfolio
is composed of value or growth stocks. With that said, a slight majority of the DCF’s securities
reflect those of growth companies.
10 | X S E I F S e m i -­‐ A n n u a l R e p o r t Individual Performance and Top Holdings:
Best Performers 1) Visa Inc. 2) McDonald's Corp. 3) Progress Energy 4) Apple Inc. 5) Intel Corp. Return 15.92% 13.83% 13.61% 10.67% 10.07% Top Holdings 1) Visa Inc. 2) Apple Inc. 3) McDonald's Corp. 4) Illinois Tool Works Inc. 5) Cognizant Tech Worst Performers 1) Peabody Energy Corp. 2) Alcoa Inc. 3) General Motors Co. 4) Express Scripts Inc. 5) Aflac Inc. Return -­‐53.26% -­‐45.01% -­‐37.74% -­‐34.00% -­‐33.79% Portfolio Weight 6.38% 6.07% 4.89% 4.34% 4.24% The above charts illustrate DCF’s Best and Worst Performers from the 6 month period ending
September 30, 2011. Notice that 3 of our 5 best performers are from the Information
Technology Sector and they also hold a large weight in the portfolio. The Information
Technology Sector is also most responsible for our excess asset return attribution. Worst
Performers include Peabody Energy and Alcoa, neither being a top holding in the portfolio.
Sector Weightings:
The above chart illustrates the each sector’s relative weight in our portfolio compared to its
weight in the S&P 500 benchmark. Overweight sectors include Information Technology and
Telecommunications, both of which have outperformed during the period.
11 | X S E I F S e m i -­‐ A n n u a l R e p o r t Xavier University
D’Artagnan Capital Fund
Strategy Statement
The D’Artagnan Capital Fund is an opportunities fund which seeks to
position itself in undervalued stocks in the marketplace utilizing a bottomup approach. Our analysts extensively research company financials,
management, and industry competitors in formulating financial valuation
models which lead to investment decisions. Our goal as a fund is to
continuously outperform our benchmark – the S&P 500 – on a riskadjusted return basis while remaining compliant in accordance with our
prospectus.
12 | X S E I F S e m i -­‐ A n n u a l R e p o r t Xavier University
D’Artagnan Capital Fund
Officer Positions
Chief Executive Officer
Student and staff appointed position at the beginning of each semester. This individual is in
charge for leading the operations as well as giving oversight to the rest of the fund per strategic
objectives. Also responsible for updating board members and other key individuals on
performance reporting and current initiatives within the fund, as well as act as a contact
between these individuals and other fund members.
Chief Investment Officer
A monthly rotated position which is in charge for all the investing-related decisions as well as
leading class discussions per each meeting. This individual initiates trade requests which the
fund analysts and managers approve upon, and acts as a liaison between the course professor
and fund members in each transaction. Also leads class discussions as well as manages day-today discussion objectives.
Compliance Officer
A monthly rotated position which is in charge of making sure current fund holdings align with
prospectus guidelines and that the fund never falls out of compliance. Updates fund members
each meeting on current state of fund and areas of concern in terms of compliance, as well as
gives trading oversight to each transaction and how it will effect overall compliance.
Economist
A monthly rotated position which is in charge of keeping up with current market and economic
trends as well as updating fund members on the current happenings. This individual gives a
brief overview of current and relevant economic events at the beginning of each fund meeting,
and is responsible for having a broad knowledge of how these economic activities effect current
fund positions.
13 | X S E I F S e m i -­‐ A n n u a l R e p o r t ECONOMIC OUTLOOK By Ryan Alleman & Joe Simoneau
Application of Economics to Fund Strategy
As a Large Cap Equity Fund, DCF monitors relevant economic events which directly affect our
fund and complement our bottom-up valuation approach. Weekly economic summaries are
shared at the beginning of each class period in order to inform analysts of important economic
events and data.
Because DCF applies a bottom-up strategy (prioritizing individual stock selection) we only
analyze economic data which can be used in tandem with our strategy. The economic outlook,
as well as the regular economic reports, is designed to provide an overview which can help guide
our decision making without influencing strategic decisions of the fund.
To supplement our strategy of valuing individual stocks, DCF analysts provide both quantitative
and qualitative data to support their recommendations. In order to do this effectively, analysts
must consider economic conditions that will directly impact each firm or sector. These economic
factors also affect our two specific valuation models; discounted cash flows and relative
valuation. In calculating the discounted cash flow models, analysts consider the economic
outlook in applying the inputs of the DCF models, specifically the growth rates that we assume
as well the interest rates. In relative analysis, analysis look for companies with competitive
advantages or disadvantages in how they are affected by macroeconomic factors, thus making
them more or less attractive in comparison to their peers.
2011 Through the 3rd Quarter
1. The 3rd quarter of 2011 saw 2.5% growth in Gross Domestic Product
2. Real GDP grew 1.3% during the 2nd quarter of 2011
3. The stock market has seen continued losses throughout the first half of the year with the
Dow losing 14% and the S&P 500 losing nearly 13%
4. Business Investment in the 3rd quarter grew by 16%
5. Consumer Spending in the 3rd quarter rose by 2.4% on an annualized basis
a. This rate is twice as fast as during the first 6 months of 2011
6. The University of Michigan’s Consumer Sentiment Index rose to 60.9 in October 2011;
up from 59.4 in September, 2011 but well below the 67.7 from a year earlier.
7. A massive earthquake and tsunami hit the eastern coast of Japan in March resulting in
damage in the hundreds of billions of dollars, including major damage to Japan’s energy
system
8. According to the University of Michigan, 57% of consumers currently see major
economic policies unfavorably – this is the highest percentage they have recorded
14 | X S E I F S e m i -­‐ A n n u a l R e p o r t 9.
10.
11.
12.
a. In contrast, only 7% of U.S. consumers see current economic policies as being
favorable
In early August, debt rating firm Standard & Poor’s downgraded U.S. debt for the first
time in history
a. While no other rating agencies followed suit, the downgrade had a significant
impact on equities markets and created a contentious political debate for
addressing the issue
Nonfarm payrolls increased at a rate 3.1% in the 3rd quarter of 2011
a. The overall unemployment rate remained high in October, at 9.0%
Real export prices grew 0.4% in October while real import prices rose by 0.3% during the
same period
The consumer price index continued to increase throughout 2011, beginning at 1.6% in
January and climbing to 3.9% in September
United States Debt Crisis
The big economic news surrounding the U.S. over the summer period was how Washington is
going to deal with debt ceiling and the growing debt issue we have. During the first quarter of
2011, things were starting to point toward a stable market state, but that would change in March
with the first signs of “double-dip” in the housing market. Along with this, Treasury and bond
yields show signs of bad times coming and the nuclear crisis takes place in Japan. The crisis in
Japan put our markets into an extremely volatile state as U.S. markets move closer to another
recession. All of these events lead up to the biggest economic news of the summer, which was
the Standard & Poor’s downgrade of the U.S. Treasury bond and the approaching debt ceiling.
These two events put the U.S. financial system under speculation as to where our markets were
going and what our government was doing to fix the state that they are in. On a positive note,
the yield on Treasury bonds moved lower showing investor confidence in the U.S. financial
system. Having the investor’s confidence in our markets over the rest of world’s markets is a
good sign moving forward and gives hope that we can reach a stable-state economy sometime in
the near future.
European Debt Crisis
Throughout the summer of 2011, the debt crisis in Europe continued to gain worldwide
attention, while impacting economic conditions. While European nations such as Greece,
Portugal and Spain have been plagued by debt issues for several years, these issues come into
greater prominence in May, becoming particularly evident in Greece. At this time, the Greek
people rejected proposed austerity measures, designed to avoid default, instead taking the
streets in protest. Due in large part to Greece’s inability to implement substantive austerity
measures, Standard and Poor’s downgraded Greece’s public debt rating to CCC – the lowest in
the world – in June. Despite widespread protests, the Greek parliament did approve a fourth
round of austerity measures over the summer. These additional austerity measures resulted in
15 | X S E I F S e m i -­‐ A n n u a l R e p o r t several tax increases, as well as the adoption of a plan from the International Monetary Fund
which would write-off Greek debt by 50%. This proposed plan remains unpopular in Greece
however, resulting in the resignation of Prime Minister George Papandreou in November. At the
time of this report, the crisis in Europe remains unresolved, and continues to have volatile
effects on the global equity market.
International Exposure
Although DCF does restrict itself to investing largely in S&P 5OO equities, we do seek
international exposure through emerging markets. This exposure allows DCF to take advantage
of growth outside of the United States and Europe, particularly in nations such as Brazil, Russia,
India & China. Several firms which DCF currently holds have significant footprints in these
emerging markets, position themselves well for long-term growth in the global economy.
2012: A Look Ahead
After such economic turmoil both domestically and globally, the DCF has numerous issues to
monitor in the near future. Given that the European debt crisis remains unresolved, it remains
the biggest issue due to the close ties it has with U.S. markets. The resolution of this crisis will
ultimately determine what direction investor confidence will go.
Another major issue moving forward is the politics that are surrounding our markets. Given the
ongoing debate amongst politicians surrounding the U.S. economy, coming elections will prove
to have a significant impact on domestic markets. With that said, the presidential election in the
fall of 2012 is hailed to be the biggest economic-oriented election since the Great Depression. A
major policy change could be the difference the U.S. economy needs to reach a stable state.
Furthermore, a final economic issue to be observed going forward involves U.S. GPD growth and
it’s correlation to unemployment. As unemployment has remained high over the past six
months, consumer sentiment has dropped to lower and lower levels. Increasing GDP growth
will ultimately lower unemployment as new jobs are created and will restore consumer
sentiment.
These highlighted issues are just some of the major drivers in our current economy going
forward. As history has shown, new events and trends are constantly developing which can
ultimately affect economies beyond the scope of reasonable forecasting. The DCF must remain
observant of developing economic actions and continue to apply their effects on company
analysis.
16 | X S E I F S e m i -­‐ A n n u a l R e p o r t CONSUMER DISCRETIONARY By Matthew Pastorcic
Sector Allocation Recommendation:
Neutral/Underweight
Current Sector Weight in Portfolio
7.64%
Current Sector Weight in Benchmark
10.81%
Benchmark Weight +- 50%
5.40%-16.21%
Sector Stocks in Portfolio
2
Sector Stocks in Benchmark
77
Portfolio Sector Beta
.82
Benchmark Sector Beta
1.06
Sector Summary
The Consumer Discretionary Sector includes all industries that provide non-essential goods and
services. Its manufacturing segment includes leisure equipment, textiles and apparel and
automotive. The services segment includes media production and services, consumer retailing,
and hotels and restaurants. Although there will always be specific opportunities that will
outperform the sector and overall market, I recommend a neutral or slightly underweight
position for the following reasons:
1. While the economy is still recovering from the 2009 recession, the recent earnings rally
seems to have priced in expected gains in the sector’s securities. Because of its cyclical
nature, being overweight in the sector during an upswing is ideal. Continuous above
expected consumer discretionary spending needs to occur in order to capitalize on
mispricing.
2. Falling unemployment will lead to increased consumer spending.
3. Price and inflation pressures on commodity costs will negatively impact consumer
spending.
4. Consumer confidence has yet to make a definitive move to the upside, showing
consumer’s mixed view of the direction of the economy.
5. Austerity measures being taken in Europe may hinder the ability of consumer
discretionary companies to sell products abroad.
17 | X S E I F S e m i -­‐ A n n u a l R e p o r t Comparative Returns
Consumer Discretionary Index vs. S&P 500
The S&P 500 experienced a sharp downturn in the last few months of the summer of 2011. U.S.
political tensions with regard to increasing the debt ceiling, European economic woes
concerning Greece’s financial stability and the civil unrest Libya are all responsible for this
sudden downturn. Almost surprisingly, the consumer discretionary sector as a whole
outperformed the S&P 500 during this time.
Sector Holdings Analysis
From the period of 3/31/2011 to 9/30/2011, the portfolio held 2 securities from within the
Consumer Discretionary Sector: McDonald’s and General Motors, representing 64.18% and
35.82% of the sector’s weight respectively. With only two securities representing the Consumer
Discretionary Sector in the overall portfolio, the sector strategy is true to the objective of an
opportunities fund, which is to put money in the best opportunities. Each of these securities
was chosen based on their standing within their industry and their opportunity to outperform
the market. Below is a breakdown of the sector weightings.
18 | X S E I F S e m i -­‐ A n n u a l R e p o r t McDonald’s Corporation (MCD)
Price: $87.82
Shares: 700
% of Portfolio: 4.90%
McDonald’s Corp. operates or franchises its nearly 33,000 fast-food restaurants in the global
restaurant industry. Roughly 80% of these restaurants are operated by franchisees, with the
remainder under the control of the company. Roughly 70% of McDonald’s 24 billion in sales
were derived internationally and the remaining 30% here in the United States.
The reason for holding McDonald’s is because the analyst believes investors haven’t realized that
it’s operating structure, changing product mix and international growth places it in a position to
outperform in the restaurant industry. McDonald’s operating structure, characterized by its
ability to generate income from both its operated and franchised restaurants gives it the ability
to generate consistent revenue from both customer demand and franchise operations. It plans
to remodel 4,000-5,000 stores in the next 4 to 5 years and continue to add unique products
such as their McCafe drinks in its efforts to increase sales. China is a key market for McDonald’s
long-term growth. McDonald’s continues to add new locations in China in its attempt to
recapture market share from YUM brands.
General Motors Company (GM)
Price: $20.18
Shares: 1700
% of Portfolio: 2.74%
General Motors Company is a global automotive company. It develops, manufactures and
markets automobiles and parts worldwide. General Motors is the nation’s largest automobile
manufacturer; sales represented nearly 20% of U.S. car and truck market in 2010. Including
strategic partnerships, GM manufactures vehicles in over 30 countries, with sales in over 120
nations. Foreign operations accounted for about 74% of 2010 sales.
The investing strategy behind General Motors is the analyst’s belief that the benefit the company
will receive from having leading market shares in developing economies, advantageous joint
ventures and securing a satisfied workforce is greater than what is priced at the current
valuation. General Motors strong presence in the international auto industry has it poised to
capitalize on the growth of developing economies. General Motors has the number one market
share in China, representing almost 10% of the country’s total auto sales and the number one
market share in South America, with 19% of the continent’s auto sales. Along with a strong
international presence, GM’s recent joint venture with the Shanghai Automotive Industry
Corporation in order to develop new fuel efficient technology may lead China to lax strict import
regulations and allow GM access to profits from China’s large population. Given the U.S. auto
industry is highly unionize and this doesn’t look like it will change in the near term, GM’s recent
favorable contract extension with the United Auto Workers Union (UAW) places it in a
competitive position. This 4 year contract includes $5,000 year-end bonuses to all employees,
while only increasing labor costs 1% annually. A possessing a satisfied and skilled labor force in
uncertain economic times is a huge asset.
19 | X S E I F S e m i -­‐ A n n u a l R e p o r t Changes in Sector Holdings
As of November 17th, there have been no changes to the holdings as described from March 31st to
September 30th. The Consumer Discretionary Sector holdings have been evaluated and it has
been agreed that it is in the best interest of the DCF to continue to hold MCD and GM, based on
their ability to generate above expected returns.
Watch List
Name
Mkt Cap
YTD Return
Pct
Beta
YTD
Rev Growth
2011
TTM
P/E
TTM
ROE
Dividend
Yield
HOME DEPOT INC
56,924.58
6.03
0.92
2.75
16.32
19.09
2.75
LOWE'S COS INC
27,151.76
(12.26)
0.93
3.38
13.99
11.00
2.60
NEWS CORP-CL A
44,630.44
16.58
1.27
1.91
13.55
10.02
1.13
NETFLIX INC
4,726.42
(48.76)
0.88
29.48
20.46
82.02
WYNN RESORTS LTD
16,449.48
28.08
1.32
37.40
25.32
13.41
1.52
MARRIOTT INTERNATIONAL-CL
A
10,593.34
(23.25)
1.23
7.18
28.22
25.77
1.27
FAMILY DOLLAR STORES
6,922.44
19.88
0.78
8.65
18.84
30.97
1.22
DOLLAR GENERAL CORP
13,410.63
28.01
0.67
10.50
19.34
16.21
-
The strategy of the sector through the end of the semester will be to look for value in industries
that are still recovering from the 2009 recession. As the housing and entertainment industries
continue to rebound, companies such as Home Depot and Wynn Resorts are in positions to
capitalize. If economic uncertainty continues, companies such and Family Dollar and Dollar
General should continue to beat expectations.
Screening Process
The screening process of this sector is to look for companies with the following requirements:
1.
2.
3.
4.
Leading market share in industry/ poised to grow in respect to competitors.
Having higher margins than competitors/ improving margins.
History of setting and meeting performance goals.
Undervalued Discounted Cash Flow and Relative Valuation Models.
Due to the number of companies and industries contained in the sector, the analyst begins with
more of a top-down approach by looking at which industries he believes are poised to grow and
outperform the rest of the sector. From there, he looks at the companies within the industry
that are poised to take advantage of the growth, usually the largest 2 or 3 companies in the
industry. Then he performs DCF and Relative Valuation Models to see if the stock seems
undervalued. If so, he performs more in-depth qualitative analysis to confirm the original
opinion.
20 | X S E I F S e m i -­‐ A n n u a l R e p o r t -
Sector Analysis
Industry Life Cycle Position
As a whole, the industries within the Consumer Discretionary tend to be in the mature stage of
their life cycle. Industries such as the restaurant, auto and media have been around for decades
and appear to have saturated the domestic market. The industry maturity phase is characterized
by increased competition and the lowering of overall prices. Growth from companies within the
sector will be derived from growth in the global economy.
Business Cycle
The consumer discretionary sector contains companies whose business cycles are highly cyclical
in nature. These companies sell products and services that are discretionary and can be added
or cut depending on the consumer’s optimism. In a rapidly growing and expanding economy
these companies will do exceptionally well, whereas in a troubled economy their business
models will struggle.
External Factors
Government
The government’s role in the discretionary sector could impact the consumer discretionary
sector’s growth based off the regulations it passes. For example, raising the debt ceiling and
cutting the budget deficit by approximately $2.4 trillion over the next 10 years may
inadvertently impact the discretionary spending power of the consumer. Public employee
benefits, along with social programs such as social security and Medicare are likely to be cut,
taking money consumers would normally spend out of their pockets.
Social
Social trends and beliefs are extremely relevant to companies in this sector as they provide
goods and services that are optional to consume. The company adjusts and adopts the next
popular trend will have an enormous competitive advantage, regardless to the economic climate.
Former examples include Abercrombie, as it was and still is a favorite among teens and
McDonald’s, whose advertising has connected with and created a relationship with children.
Foreign
The emergence of a global middle class has a great influence on companies within the consumer
discretionary sector. As developing countries expand, billions of new customers are entering
into the discretionary market and are targets of these companies. Consumer Discretionary
companies are tailoring their goods and services to fit the needs of possible new customers.
Consumers in China have begun to show significant interest in attaining luxury goods,
representing a large potential market for companies like Tiffany and Nordstrom if they can
adapt and adjust their products to fit demand.
21 | X S E I F S e m i -­‐ A n n u a l R e p o r t Analysts Future Outlook
Major economic indicators that I feel will predict the overall performance of the Consumer
Discretionary sector includes:
1.
2.
3.
4.
Unemployment Rate
Consumer Price Index
Consumer Confidence
Implementation of Austerity Measures
Unemployment Rate
Job creation in the public sector has lagged private sector growth. Government jobs have
continued to be cut, while only a small amount of jobs have been added. President Obama’s
proposed American Jobs Act includes reducing overall payroll taxes for 98% of businesses and
eliminating payroll taxes for added workers. If this act passes, private sector employment
growth could continue and the overall unemployment rate fall.
Unemployment is critical to the overall financial success of companies within the Consumer
Discretionary Sector. It gives consumers more discretionary income and also lowers the overall
fear in the economy, boosting consumer confidence and their willingness to may discretionary
purchases, leading to higher revenues for companies within the sector. The overall
strengthening of the economy, along with possible assistance from congress leads me to believe
unemployment will continue to fall.
Consumer Price Index (CPI)
A drawback in investing within the Consumer Discretionary Sector is the steady rise of
consumer prices, as measured by the CPI. Below is a graph of the monthly CPI. CPI was at its
lowest point during the 2009 recession at 2.1% and has risen steadily since to its current level of
3.9%. Inflationary pressures on commodities such as energy, food and paper will hinder overall
consumer spending. Turmoil in the middle-east and the overall increase in harvesting costs are
responsible for this increase. The portfolio’s current holdings in General Motors and
McDonald’s are both prepared to adjust to a rise in overall prices.
One way consumers are looking to spend less on gas is by switching to more fuel efficient
automobiles. After its 2010 bankruptcy, General Motors has restructured and revamped several
of its brands, including selling off several of its unsuccessful brands such as Hummer and
Saturn. General Motors is committed to developing better fuel efficient technology as shown
both by its recent joint venture with the Shanghai Automotive Industry Corporation and by
expanding its fleet. Earlier this month, General Motors introduced its all new electric car, the
Spark. Other electric vehicles include the Volt, Sail, Cruze and Beat. General Motors is poised
to capitalize as consumers begin favoring fuel efficient vehicles.
McDonald’s dominating presence both in the U.S. and abroad gives it the pricing power to offset
some of the elevated commodity costs. Its management has an excellent track record and has
been pushing to increase its internal operating efficiency to cut down on waste.
22 | X S E I F S e m i -­‐ A n n u a l R e p o r t Although our holdings are prepared for the increase in commodity prices, it negatively affects
the overall sector performance. Consumers will be spending more on mandatory home
expenses such as heating and cooling and less on discretionary goods.
Consumer Confidence
Another threat in investing in the Consumer Discretionary Sector is the consumer confidence
level. Consumer Confidence is a measure of consumer’s overall willingness to spend along with
their view of the direction of the overall economy. Below is a graph depicting the U.S. consumer
confidence from 2005 to September, 2011. It reached a pre-recession high of 97 and has
dropped off significantly since. Consumer confidence has moved horizontally between 2009
and 2010 and then has dropped in the past summer months. The U.S. consumer confidence
hasn’t made a significant move upward since moving out of the 2009 recession. Consumer’s
hesitant view on the overall direction of the economy does not give a good outlook for their
discretionary spending.
23 | X S E I F S e m i -­‐ A n n u a l R e p o r t Austerity Implementation
Both Europe and the United States have been making attempts to cut their budget deficits. One
of the biggest targets for cuts is that of hiring freezes and wage cuts, coinciding with increased
taxes in many cases. Greece announced on September 21, 2011 that it will lower the threshold
above which income is taxed to $6,800 annually from about $11,000. It announced cutting
pensions above $1,600 a month and cutting the wages of government employees by 5%.
Portugal has imposed a hiring freeze in the public sector, along with a freeze in salaries and an
increase in VAT tax. Italy is currently in discussions regarding raising the retirement age in
order to help cut their national debt. The United States’s recent debt ceiling agreement includes
cutting the budget by an approximate $2.4 trillion over the next 10 years. The U.S. has also
been slashing public sector jobs.
With many of the companies within the Consumer Discretionary Sector having operations
internationally, austerity measures limiting consumer spending will have a negative effect on
both consumers’ ability and willingness to spend. Both of our current holdings, General Motors
and McDonald’s generate a great deal of their revenues internationally and these austerity
measures may negatively impact their ability to generate sales.
Conclusion
While a steady decline in unemployment in the United States is a good sign for overall sector
performance, it is tempered by rising commodity costs, mixed consumer sentiment and the
implementation of global austerity measures. These facts, along with the recent rally pricing in
high earnings expectations for the sector overall, are the basis for recommending a neutral or
underweight sector holding in the portfolio.
24 | X S E I F S e m i -­‐ A n n u a l R e p o r t CONSUMER STAPLES By Steve Latos and Steve Rosenbaum
Sector Allocation Recommendation:
Current Sector Weight in Portfolio
Current Sector Weight in Benchmark
Benchmark Weight ± 50%
Underweight
8.73%
11.76%
5.88-17.63%
Sector Stocks in Portfolio
4
Sector Stocks in Benchmark
41
Portfolio Sector Weighted Average Beta
0.59
Benchmark Sector Weighted Average Beta
0.67
Sector Summary
The consumer staples sector includes companies whose businesses are less sensitive to
economic cycles. The companies within the sector include manufacturers and distributors of
food, beverage and tobacco and produce of non-durable household goods and personal
products. It also includes food and drug retailing companies as well as hypermarkets and
consumer super centers.
The consumer staples sector has historically had a low correlation relative the market (current
weighted average beta of S&P 500 Consumer Staples firms is 0.71). This results from the makeup of the products within the sector. Due to these two facts, this sector is typically outperforms
other sectors in economic downturns, and underperforms other sectors in boom periods.
The products have a low price elasticity of demand, meaning a change in prices will have a small
effect on the demand for goods. Given this, a change in price can move a consumer from one
product to a substitute, thus pricing in the consumer staples sector plays an important role.
Other notes:
1.) Given the defensive nature of the sector, these companies generally tend to depend less
on strong growing economies.
2.) Given the increase in consumer spending and consumer sentiment, near future outlooks
are brighter, as consumers will be able to move to premium brands.
25 | X S E I F S e m i -­‐ A n n u a l R e p o r t 3.) Consumption represents 70% of the economy, further proof of the defensive nature of
the sector.
4.) Although continued economic growth will prove to be beneficial for the sector, top-line
growth does not appear to be great given the mature nature of the firms within the
sector.
5.) If the U.S. dollar gains strength against other currencies, a majority of companies within
the sector could experience negative operating results because companies will have to
pay more to sell their exports.
6.) The following chart tracks the performance of the sector through the period 04/01/2011
to 09/30/2011.
Comparative Returns
Consumer Staples Index vs. S&P 500
The S&P 500 Consumer Staples Index is representative of the return of the consumer staples
sector and the S&P 500 index is representative of our benchmark return. Through the period
04/01/2011 to 09/30/2011, the Consumer Staples Index outperformed the S&P. The staples
sector hit its low of -5% in mid-August, while the benchmark hit its low of -15% also in midAugust. The staples sector had a positive return for the majority of the period, whereas the
benchmark provided a negative return for the majority of the period.
26 | X S E I F S e m i -­‐ A n n u a l R e p o r t Strengths and Weaknesses
Strengths
As mentioned above, a company that provides staple products involves the basic necessities of
life, so consumers will continue to purchase these goods in stressful economic times. The point
can be illustrated by the performance of the sector from March 31, 2011 through September 30,
2011. Despite a large drop in the S&P 500 in August, the 40 consumer staples firms in the S&P
500 outperformed the entire S&P 500 by 14.46%.
One of the main reasons that the sector can maintain fairly consistent sales over time is their
ability to create a wide economic moat through brand recognition. For example, companies
such as Wal-Mart and Proctor & Gamble are reputable firms that have been a large player in the
United States economy for several decades. In other sectors, such as information technology,
companies can emerge from nowhere by being the first to an innovative idea.
The consistency of cash flows to consumer staple firms can be proven by the firms’ ability to pay
out dividends to shareholders. Of the 40 consumer staples firms in the S&P 500, 38 pay a
dividend. The only two that do not, Dean Foods Co and Constellation Brands rank 38th and 39th,
respectively in terms of market cap within the firm. The quintessential example of a dividend
payer is Proctor and Gamble, who has issues a dividend for the past 121 years, increasing the
dividend in each of the last 55 years.
Weakness
With increased commodity costs, companies within the Consumer Staples sector, especially
those producing food, beverage, and household items, have had to find a way to offset the
increased input costs. Some companies, such as Kellogg, have focused on collecting customer
preference and taste information to produce a higher quality product. In addition to gathering
customer data, Kellogg has developed a new marketing campaign to promote these new and
improved products. Other companies, such as Pepsi, have passed costs onto customers in order
to battle ever-tightening margins.
Besides higher costs due to increased commodity prices, the sector as a whole has put an
emphasis on producing products for a wide demographic of people because of the volatile
economic market. Procter & Gamble, for example, which produces household items such as soap
and detergent, has created a lower-end soap and detergent in Gain, geared for those who are
more cost sensitive. Tide, on the other hand, is a higher-end P&G product, retaining client that
are less cost sensitive. By creating products for all demographic, companies within this sector
are trying to retain market share and client loyalty.
27 | X S E I F S e m i -­‐ A n n u a l R e p o r t Sector Holding Analysis
As of September 30, 2011, the D’Artagnan Capital Fund currently held 4 stocks in the Consumer
Staples sector. These stocks are Wal-Mart Store Inc., PepsiCo Inc., Kellogg Company, and
Procter and Gamble. Compared to our S&P 500 benchmark, our fund is currently
underweighted in the sector. Below are brief descriptions for each of the holdings.
Wal-Mart Stores, Inc (WMT)
Price: $51.90
Shares: 375
Percentage of Portfolio: 1.55%
Percentage of Sector: 17.78%
View: A new development for Wal-Mart stores is their unveiling of new Wal-Mart Express
stores. These stores will average approximately 15,000 square feet, compared to Wal-Mart
Supercenters of over 150,000 square feet. While these stores will add to sales, the products to
be offered at these stores will be consumable items with lower margins, which may lower the
company’s overall EBIT margin in the long-term future.
Wal-Mart is one of the companies on our watch list, since it is nearly impossible for a store to
retain such market power over an extended period of time. When market share does begin to
decrease, factors such as Net Fixed Assets and Non-Cash Working Capital will impact WalMart’s stock price in a negative fashion. Current Discounted Cash Flow and Relative Valuation
techniques have led to our analysts believing Wal-Mart’s current intrinsic value is about $55
dollars. If that price is reached, look for the fund to sell Wal-Mart.
PepsiCo Inc (PEP)
Price: $61.90
Shares: 600
Percentage of Portfolio: 2.96%
Percentage of Sector: 33.93%
View: PepsiCo, Inc. is a global food, snack and beverage company. In addition to producing soft
drinks such as Pepsi and Mountain Dew, PepsiCo also sells Tropicana orange juice, Gatorade
sports drink, and Aquafina water. Their snack business is composed primarily of Frito-Lay, the
world’s number one snack maker. The 600 shares of PepsiCo held by the Fund make Pepsi the
largest holding in the Consumer Staples sector.
Pepsi did not prove to have a strong of 2010 as many expected, due to an increase in
commodity prices and a downturn in demand for carbonated beverages. Pepsi has
responded by shifting its focus to more healthy products; the company has set a goal that
30% of its portfolio will consist of healthier products. Currently, that figure is 22%. Being
28 | X S E I F S e m i -­‐ A n n u a l R e p o r t able to adapt to consumers, as well as the possibility for increased sales in overseas markets
suggest a bright future for Pepsi.
Kellogg Company (K)
Price: $53.19
Shares: 400
Percentage of Portfolio: 1.70%
Percentage of Sector: 19.44%
View: Kellogg Company is engaged in the manufacture and marketing of ready-to-eat cereal and
convenience foods with their main products being: cereals, cookies, crackers, and fruit-flavored
snacks among many other. As of February 25, 2011, these products were manufactured by the
Company in 18 countries and marketed in more than 180 countries.
Due to pressures faced from increased commodity prices, Kellogg has passed costs onto
consumers to offset the additional costs of product inputs. In turn, Kellogg has paired with
Epsilon, a subsidiary of Alliance Data, a leading provider of loyalty and marketing solutions, to
increase Kellogg’s customer engagement. Through the partnership, Kellogg will maintain a
consumer relationship management platform with which it can analyze customer tastes and
preferences. With an already strong market position, and a dedication to improving its products,
look for Kellogg’s sales growth to improve even in times with volatile commodity prices,
eventually leading to higher profits.
Procter and Gamble (PG)
Price: $63.18
Shares: 500
Percentage of Portfolio: 2.52%
Percentage of Sector: 28.86%
View: The Procter & Gamble Company (P&G) is focused on providing consumer packaged
goods. The Company’s products are sold in more than 180 countries primarily through mass
merchandisers, grocery stores, membership club stores, drug stores and high-frequency stores,
and neighborhood stores. The company operates through three business units: Beauty and
Grooming, Health and Well-Being, and Household Care.
Given P&G’s size, they gain advantages in terms of distribution, brand reach, and scale with
suppliers. Throughout its history, P&G has proven to be an outstanding company that can
change with the times and the markets it operates in. In turn, P&G is focusing on both higherend and lower-end consumers.
29 | X S E I F S e m i -­‐ A n n u a l R e p o r t P&G recently announced a joint venture with Powermat Ltd., the leader in wireless charging.
With joint ventures, such as the Powermat case, or acquisitions such as Gillette, P&G has shown
a commitment to increasing business operations. Combine P&G’s ambition to acquire new
business, its market power, its historical success, and its commitment to dividends (P&G has
paid a dividend for 121 consecutive years); P&G is a healthy hold.
Changes in Sector Holdings
Both CVS Caremark Corp (CVS) and Diageo Plc-Sponsored (DEO) were sold during the last halfyear. Below are reasons for the sales:
CVS Caremark Corp (CVS)
Sell Price: $36.43
Number of Shares: 200
Sale Date: 5/10/2011
View: CVS Caremark Corporation (CVS Caremark) is a pharmacy healthcare provider in the
United States. It provides pharmacy services through its pharmacy benefit management mail
order and specialty pharmacy division. CVS has an alliance with Alere, LLC, which helps them
offer programs covering several chronic diseases such as asthma, diabetes, congestive heart
failure, and coronary artery disease.
The main reason D’Artagnan Capital Fund decided to sell CVS was due to several risks that face
the firm. The current economic uncertainties have led customers away from the front-end goods
produced by CVS, which will put a damper on sales growth in the near future. In addition, a
problem facing many consumer staple firms, rising commodity prices, will lead to lower
margins. Finally, uncertainty with government regulations in the health care industry was a
concern that could be avoided with other securities in the sector.
Diageo PLC (DEO)
Sell Price: $81.15
Shares: 200
Sale Date: 5/10/2011
View: Diageo plc (Diageo) is engaged in the drinks business with a collection of international
brands with eight of the world’s top 20 brands. Given Diageo’s strong portfolio of liquor and
beer, the company continues to be the leader in its industry. However, in the recent economic
downturn, Diageo’s premium brands have reduced sales growth as people trend towards other,
more affordable beverages.
30 | X S E I F S e m i -­‐ A n n u a l R e p o r t In addition to sluggish sales growth, Diageo is facing increased pressures on its margins as a
result of higher commodity prices. With Diageo’s limited growth and squeezed margins, the
company will have to look for mergers and acquisitions to increase firm value.
Potential Targets
The following seven companies have been discussed amongst the Consumer Staples analysts as
potential buys. Included are statistics for each company measuring size, risk, return, and
efficiency.
Name
ALTRIA GROUP INC
KIMBERLY-CLARK CORP
MOLSON COORS BREWING
DIAGEO PLC-SPONSORED
DEAN FOODS CO
KRAFT FOODS INC
Average
Mkt Cap
56284.29
27312.57
7297.25
52441.49
1849.34
62154.22
44217.87
Ret
YTD
Pct
16.24
14.13
-20.93
16.77
13.91
14.59
7.84
Beta
YTD
0.66
0.60
0.85
0.80
1.09
0.66
0.76
Rev - 1 Yr
Gr:Y
0.40
3.30
7.32
1.60
9.08
26.97
10.01
P/E
13.89
14.74
11.74
17.17
16.24
16.14
14.89
ROE
LF
72.57
31.04
7.91
41.07
-1.47
9.06
24.86
Dvd
Yld
5.99
4.02
3.29
3.77
0.00
3.30
3.13
Sector Breakdown
Beverage
Due to increased commodity costs and no real growth in demand, companies within the
beverage industry have to either pass increased input costs onto consumers or find a way to
improve manufacturing efficiency. S&P staples such as PepsiCo and Coca-Cola are the main
companies within the beverage industry, but global alcoholic beverage company Diageo has also
faced increased pressure with its higher-end brands lagging in a volatile economic climate.
Household & Personal Care Products
Because of continued economic volatility, the main focus within this industry has been the
development and promotion of higher and lower end products. Companies like P&G are
developing products such as Gain detergent to market to consumers with tighter budgets, while
still producing Tide, its higher end detergent.
Packaged Food
Companies within this industry, such as Kellogg, H.J. Heinz, General Mills, and Kraft are all
facing increased commodity prices. To offset the costs of increased commodities, these
companies are focusing on marketing and client management to improve products and focus on
consumer tastes and preferences in order to improve sales.
31 | X S E I F S e m i -­‐ A n n u a l R e p o r t Retailing – Broadlines and Department Stores
Because of the increase in social media in today’s day and age, the retail industry is focusing on
this media to drive sales growth. Nearly seventy percent of retail executives have reported
increases in marketing and deals through sites such as Facebook and Twitter. A majority of
these executives expect sales to grow over the next twelve months.
*Source: WSJ-Study based on results of September 2011 survey of 100 retail industry executives at U.S. middle market retail
companies (revenues of $25 million to $1 billion).
Retailing – Food
Given the minimal barriers to entry and strong competition from dollar stores, warehouse clubs,
etc., this industry continues to be competitive. Additionally, with increased commodity costs,
food prices have also increased, separating consumers into a high-end and low-end grouping.
Tobacco
Health concerns have led to a decrease in the percentage of smokers worldwide. However, with
the population rising, the number of smokers worldwide has actually increased. Still, health
concerns and marketing efforts will tend to generate a negative attitude towards tobacco
products. Combining that with increased government taxes and regulations, and the long-term
outlook for tobacco is shaky. Analyst’s Future Outlook
Our recommendation for the Consumer Staples sector is to continue to underweight given the
continued, although not robust, growth the economy is experiencing. Our fund is an
opportunities fund, and while we say we expect the sector to be underweight in the future, it will
ultimately be proven in our valuation models. In the discounted cash flows model, sales growth
rates will not be as high as companies in other sectors that will benefit more from a better
economy. The other alternative is the potential for a double-dip recession. While these are rare,
sales growth would be better for staples than for in other sectors, as evident in 2008 and 2009
financial statements. Since the chance of a double-dip is small, we will look to keep the sector
underweight for the foreseeable future.
32 | X S E I F S e m i -­‐ A n n u a l R e p o r t ENERGY By John Barber
Sector Allocation Recommendation:
Overweight
Current Sector Weight in Portfolio
13.21%
Current Sector Weight in Benchmark
12.29%
Benchmark Weight ± 50%
6.14-18.43%
Sector Stocks in Portfolio
6
Sector Stocks in Benchmark
39
Portfolio Sector Beta
1.12
Benchmark Sector Beta
1.26
Sector Summary
Since March 31, 2011, both the S&P 500 and the Energy Sector have seen losses in returns. The
sector as whole has been more volatile in performance against the index, underperforming
throughout the period and a steep slide in returns from summer to fall.
Comparative Returns
Energy Index vs. S&P 500
33 | X S E I F S e m i -­‐ A n n u a l R e p o r t Strengths and Weaknesses of the Sector
Strengths
•
Relatively low variable costs
•
Current lack of cost-effective alternatives to oil, gas, and coal
•
Growing demand from emerging markets
Weaknesses
•
High exploration and production costs
•
Volatility
•
Difficult to manage oversight liabilities for world-wide operations (e.g., BP)
•
Political instability in the areas where oil is primarily extracted
Energy is an exciting sector characterized by volatility due to global demand shocks and supplyside uncertainties due to political instability in the areas where oil is primarily extracted. Energy
companies also have large amounts of capital expenditures necessary for the exploration and
extraction of oil and natural gas. Therefore, these firms have a high degree of operating leverage
(high fixed costs). Thus, if one assumes the economy will emerge from its recent slow-growth
lull, energy would be an advantageous asset allocation as the sector would benefit from growing
energy needs that accompany economic expansion, and outperform the market. Unfortunately,
as we have seen over the course of the reporting period, the sector has underperformed the
benchmark in a weak overall economy.
Sector Holding Analysis
As of September 30, 2011, the fund owned six energy stocks (BP, CVX, TOT, BTU, XOM, CHK)
whose holdings represented 12.57% of the fund’s market capitalization.
DCF ENERGY HOLDINGS as of SEPTEMBER 30, 2011 Market
Capitalization
Total
Revenue
(LTM)
EBITDA
(LTM)
EBITDA
Margin
(LTM)
ROE
EV/EBITDA
(LTM)
BRITISH PETROLEUM
$138.57B
$361.78B
41.12B
12.96
19.72
4.06
6.07
2.89
1.04
CHEVRON CORP
$211.95B
$229.69B
56.31B
20.27
23.51
4.71
7.89
3.11
1.01
TOTAL SA
$121.21B
$222.42B
44.13B
19.96
19.52
3.72
6.97
5.75
1.16
$11.80B
$7.61B
1.91B
26.05
20.64
10.51
12.55
0.46
1.45
$376.36B
$419.53B
69.76B
16.07
26.43
6.87
9.48
2.38
0.97
$17.89B
$11.95B
5.22B
49.49
12.41
6.57
18.02
1.16
1.20
Company Name
PEABODY ENERGY CORP
EXXON MOBIL CORP
CHESAPEAKE ENERGY CORP
P/E
(LTM)
Dividend
Yield (%)
Beta
34 | X S E I F S e m i -­‐ A n n u a l R e p o r t British Petroleum (NYSE: BP)
Close Price (9.30.2011): $36.07
Total Shares Owned: 1140
Period Return (v. Sector): -16.70% (+7.46%)
Percent of Portfolio (Sector): 3.28% (26.09%)
BP p.l.c. (British Petroleum) is an international oil and gas company. Their business included
providing fuel for transportation, energy for heat and light, retail services and petrochemicals
products. The company focuses on two segments: Exploration and Production (9.8% of revenue
for 2010), and Refining and Marketing (89.3 % of revenue for 2010). Three areas related to E &
P. First, Upstream involves the actual exploration for oil and natural gas assets that are
economically viable for the company and the development of these assets. Second, Midstream
involves the transportation and processing of the oil and gas extracted from their assets. Lastly,
Marketing and Trading involves the retail/sale side of natural gas, crude oil and petrochemical
products.
Chevron Corporation (NYSE: CVX)
Close Price (9.30.2011): $92.59
Total Shares Owned: 440
Period Return (v. Sector): -12.50% (+11.66%)
Percent of Portfolio (Sector): 3.25% (25.85%)
Chevron Corporation (Chevron) is comprised of multiple businesses that will provide energy for
the future of human progress. This includes Exploration & Production, Manufacturing,
Products, Transportation, Chemicals, Mining and Technology. Chevron has major investments
in the top oil and gas regions of the world such as the United States, Kazakhstan, Australia,
Thailand, Angola, Nigeria and other countries. Additionally Chevron provides refining
operations that are place in some of the fastest growing markets. Also they own pipeline and
shipping interests which allow them to eliminate conflict with other companies. Other
businesses include chemical production, mining of coal and rare earth metals, and innovative
technological research will solve problems in the future.
Total SA (NYSE: TOT)
Close Price (9.30.2011): $43.87
Total Shares Owned: 600
Period Return (v. Sector): -24.61% (-0.50%)
Percent of Portfolio (Sector): 2.10% (16.70%)
35 | X S E I F S e m i -­‐ A n n u a l R e p o r t TOTAL S.A. is a French international oil and gas company with operations in about 130
countries. These operations are split up into four segments: Upstream, Downstream, Corporate
and Chemicals. In the Upstream segment, they focus on oil and gas exploration, development
and production, liquefied natural gas. In the Downstream segment, they focus on refining,
marketing and the trading and shipping of oil. Outside of their basic oil and gas operations,
investments in coal mining and power generations have been made. They also have part
ownership in a company called Sanofi-Aventis, which is a pharmaceutical company based in
Bridgewater, NJ. Peabody Energy Corporation (NYSE: BTU)
Close Price (9.30.2011): $33.88
Total Shares Owned: 250
Period Return (v. Sector): -52.79% (-28.63%)
Percent of Portfolio (Sector): 0.68% (5.37%)
BTU (Peabody Energy Corp.) is the largest private-sector coal company in the world
headquartered in downtown St. Louis, MO. Peabody mines and markets predominantly low
sulfur coal, primarily for use by electric utilities. The company also trades coal and emission
allowances. Peabody owned U.S. owned mines are in Arizona, Colorado, New Mexico, Wyoming,
Illinois, and Indiana. The company also owns a minority interest in a Venezuelan mine through
a joint venture.
Exxon Mobil Corporation (NYSE: XOM)
Close Price (9.30.2011): $72.63
Total Shares Owned: 300
Period Return (v. Sector): -12.60% (+11.56%)
Percent of Portfolio (Sector): 1.74% (13.83%)
Exxon Mobil Corporation operates petroleum and petrochemicals businesses on a worldwide
basis. The company’s operations include exploration and production of oil and gas, electric
power generation, and coal minerals operations. Exxon Mobil also manufactures and markets
fuels, lubricants, and chemicals. Exxon enjoys the largest market capitalization of the sector and
remains near the top of the S&P 500 in the same category.
Chesapeake Energy Corporation (NYSE: CHK)
Close Price (9.30.2011): $25.55
Total Shares Owned: 750
36 | X S E I F S e m i -­‐ A n n u a l R e p o r t Period Return (v. Sector): -23.23% (+0.86%)
Percent of Portfolio (Sector): 1.53% (12.16%)
Chesapeake Energy is the second-largest producer of natural gas. Located in Oklahoma City, the
company is looking for ways to discover and develop economically profitable natural gas and oil
fields onshore in the U.S. Currently, Chesapeake manages positions in the Barnett, Fayetteville,
Haynesville, Marcellus and Bossier natural gas shale plays and the Eagle Ford, Granite Wash,
Cleveland, Tonkawa, Mississippian, Wolfcamp, Bone Spring, Avalon, Niobrara and Williston
Basin liquid plays. In addition, the company vertically integrates its operations and owns
midstream, compression, drilling and oilfield service assets. The CEO Aubrey McClendon has
been in charge since the foundation of the company and is the largest holder of the company’s
stock with about 3 million shares. Another large holder is Carl Icahn, who has acquired a 5.8%
share and looks for management to limit spending.
CHANGES IN SECTOR HOLDINGS
PURCHASES:
• BRITISH PETROLEUM (MAY 2011)
• CHEVRON (MAY 2011)
SELLS:
• Transocean LTD (May 2011)
• Devon Energy Corp. (May 2011)
Stock Screening
The D’Artagnan Capital Fund is determined to find undervalued companies that provide
opportunities within our S&P 500 universe. Therefore the issue of screening various stocks to be
able to pick a small sample of companies to value is obvious. The process is as follows:
1. Initially, a relative valuation analysis is developed for each of the current holdings. To
save some time, a template of relevant information is already saved within my
Bloomberg Account. This template consists of the following information that I believe to
be important: Last Price, Market Capitalization, Beta, P/E T12M, EPS T12M, BEst: P/E:
Year, BEst: EPS F12M, EV/EBITDA T12M, EBITDA T12M, BEst EV and BEst EBITDA
F12M.
2. With this information, the 20 closest companies to the holding’s market capitalization
are analyzed. To see where the comparable firms lie within their industry, the average
and median is calculated for each statistic.
3. Trailing PE is the first column analyzed. If a company is trading at a PE multiple 2 below
the average and median, it is put that on the watch list.
37 | X S E I F S e m i -­‐ A n n u a l R e p o r t 4. Future PE is the second column analyzed. If a company’s predicted EPS is higher than
the trailing EPS and the PE is predicted to decline, it is put that on the watch list.
5. Trailing EV/EBITDA is the third column analyzed. If a company is trading about 2 below
the average and median multiple, it is put that on the watch list.
6. The last column analyzed is created by dividing BEst EV over BEst EBITDA F12M. This
creates a list of future EV/EBITDA multiples. If a company is trading 2 below the
average and median multiple, it is put on the watch list.
7. Before performing the DCF approach, eliminate all companies that do not fit the
prospectus’s requirements of likeable to the S&P 500 in terms of marketability and
capitalization.
8. Outside of this research, it is important to keep up to date on any energy stocks in the
news and when each company release of earnings. It is also important to look at 1
month, 3 month and 6 month performance statistics. As an opportunities fund, checking
for beaten down stocks is a great technique to start a position if the valuation model
supports your decision.
Prospects
Based off screening strategy, alongside some preliminary qualitative analysis, the following
represent prospects with the highest potential for this sector, sorted by preference of
purchase.
Murphy Oil Company (NYSE: MUR)
MUR (Murphy Oil Corp) is a worldwide oil and gas exploration and production company
with refining and marketing operations in the US and UK. The company also has exploration
and production activities in countries that include the US, Canada, the UK, Malaysia, and
Ecuador. Murphy Oil has retail operations in the US as well. Murphy is joining with
Vendgogh LLC to pilot “gas island vending” at select Murphy USA stores in Arkansas,
Georgia, and North Carolina (installation set for this month).
Noble Energy, Inc (NYSE: NBL)
Noble Energy, Inc. is an independent energy exploration and production company. The
company explores for and produces crude oil, natural gas, and natural gas liquids. Noble
Energy operates primarily in the Rocky Mountains, Mid-continent, and deepwater Gulf of
Mexico areas in the US, with key international operations offshore Israel, the North Sea, and
West Africa.
38 | X S E I F S e m i -­‐ A n n u a l R e p o r t Sector Breakdown
Coal
Coal production is the amount of coal that is mined and sent to market. In 2010, the amount of
coal produced at U.S. coal mines was 1,085.3 million short tons. Coal is mined in 26 States.
Wyoming mines the most coal, followed by West Virginia, Kentucky, Pennsylvania, and
Montana. Coal is the most common fuel for generating electricity in the United States. In 2010,
45% of the Country's nearly 4 trillion kilowatthours of electricity used coal as its source of
energy.
Petroleum
Primarily, Petroleum is used for gasoline, diesel fuel, heating oil, and propane. Also, Petroleum
can be burned to produce hot combustion gases to turn a turbine or to make steam to turn a
turbine. Residual fuel oil, a product refined from crude oil, is often the petroleum product used
in electric plants that use petroleum to make steam. Petroleum was used to generate just over
1% of all electricity in the United States in 2010.
Natural Gas
Natural gas, in addition to being burned to heat water for steam, can also be burned to produce
hot combustion gases that pass directly through a turbine, spinning the turbine's blades to
generate electricity. Gas turbines are commonly used when electricity utility usage is in high
demand. In 2010, 24% of the Nation's electricity was fueled by natural gas.
Nuclear, Alternatives, & Renewables
This includes hydropower, biomass, bio-fuels (ethanol & biodiesel), wind, geothermal, and solar.
There are currently no Energy stocks in the S&P 500 that operate primarily as alternative energy
companies; however, some companies in the Utilities sector do capture these lines of business.
Analysts Future Outlook
The Energy Sector is an integral part of the S&P 500. In the long-term, the companies that will
survive are those that can meet consumer energy demand despite dwindling supplies of nonrenewable energy. On the other hand, for the near future coal and oil are the cheapest and most
efficient forms of energy. The sector is currently overweight in our portfolio which puts the
D’Artagnan Capital Fund in a position to outperform our benchmark as the economy improves
and the Energy Sector benefits from growing demand. Market-timing, however, has historically
proved to be one of the most difficult tasks in investing; therefore, my strategy will remain at the
security-selection level exploiting mispricing in the market of individual stocks.
39 | X S E I F S e m i -­‐ A n n u a l R e p o r t FINANCIALS By Joseph Simoneau
Sector Allocation Recommendation:
Underweight
Current Sector Weight in Portfolio
11.74%
Current Sector Weight in Benchmark
13.50%
Benchmark Weight ± 50%
6.75-20.25%
Sector Stocks in Portfolio
6
Sector Stocks in Benchmark
81
Portfolio Sector Weighted Average Beta
0.86
Benchmark Sector Weighted Average Beta
1.28
Sector Summary
Due to the performance of the overall market during the summer months, the returns have been
extremely low especially in the financial sector. Our holdings in banks saw losses over the
summer and insurance did not do much better. In such a instable economic time, holding a
financial can be very risky. So many different aspects of the global environment attribute to how
the world markets do, especially the financial market. Financials have had the worst return of
any sector in the recent months, as shown in the graph above. With everything going on,
including the massive government regulations being placed on these companies, the financial
market is at one of its most sensitive points in recent history. Looking forward, 2012 seems to be
bringing a stronger financial field and hopes for economic stability on a global basis.
40 | X S E I F S e m i -­‐ A n n u a l R e p o r t Comparative Returns
Financial Index vs. S&P 500
Strengths and Weaknesses
Strengths
The financial sector has been the one sector as of late that has had very little strength. There
have not been many redeeming qualities surrounding financial securities these days due to the
extremely volatility in those markets. One possible strength, though, could be the attention that
they are getting. Because of how worried people are about the financial stocks it shows that the
future could be good for them. People are showing concern for banks and this can be good since
they will be the first priority to get back to a stable state.
Weaknesses
The main weaknesses in financials are the debt issues in Europe and in the U.S. and the lack of
stability in world markets. Each day the market fluxuates in one direction heavily and then does
the opposite the next day. This is mainly due to the Eurozone financial crisis and Greece’s fiscal
downturn. If a solution to their problems can be reached we should see some stability returning
to the markets, but in the meantime this remains issue number one surrounding the future of
the financial sector.
41 | X S E I F S e m i -­‐ A n n u a l R e p o r t Holding Analysis
Ticker
Company Name
jpm equity
JPMorgan Chase & Co
usb equity
pnc equity
key equity
Price
$ 33.28
US Bancorp
$ 25.94
PNC Financial Services Group Inc$ 53.87
KeyCorp
$ 7.47
Market Cap (in millions) Tier 1 Capital
$ 126,456.20
12.10%
$ 49,504.00
10.50%
$ 28,341.66
12.10%
$ 7,118.07
15.16%
Price/Book ROE
Beta
Provisions
1.13 $ 16,639.00
$ 0.72
9.76%
1.10 $ 4,356.00
$ 1.62
12.67%
1.21 $ 2,502.00
$ 0.87
10.93%
1.33 $ 638.00
$ 0.74
4.64%
J.P. Morgan (JPM)
Last price (9/30/11): $29.86
Shares: 780
% of sector: 15.96%
% of portfolio: 1.87%
Headquartered in New York City, JPMorgan Chase, the U.S.’s second largest bank behind Wells
Fargo, has continued to struggle through the problems that the financial crisis has left them.
Now, with the summer financial downturn, JPM’s stock has taken more hits due to the fiscal
crisis in Europe because of their debt obligations overseas. The fund holds JPM because their
stock has already absorbed the European debt crisis and is overreacting to the current market.
US Bank Corp. (USB)
Last price (9/30/11): $23.54
Shares: 300
% of sector: 4.80%
% of portfolio: 0.56%
US Bancorp is a regional bank based in the Midwest that provides financial services to all sorts
of clients. They have fared well throughout the financial crisis and leads major U.S. banks in
one-year revenue growth at 5.74%. USB has done a great job of keeping their debt obligations in
check, which is a major reason why they were able to go through the summer almost completely
unscathed. USB provides the fund with good security in the financial sector based on their
quality of credit, upper management strategies and asset allocation.
PNC Financial Services Group (PNC)
Last price (9/30/11): $47.86
Shares: 1100
% of sector: 36.01%
% of portfolio: 4.23%
Like USB, PNC Financial Services is a regional bank and is headquartered out of Pittsburgh,
Pennsylvania. PNC is another bank that has handled the 2008 financial crisis fairly well, but the
summer crisis took a small toll on their stock price. Since the summer downturn, things have
42 | X S E I F S e m i -­‐ A n n u a l R e p o r t looked much better as their projections for the third quarter have gone up. PNC is expected to
finish a deal with the Royal Bank of Canada’s U.S. unit in early 2012. This will expand their
growth potential significantly and improve their already high value as a company. Their growth
potential and risk management have been two of the main factors behind the fund’s position to
hold them.
Key Corp. (KEY)
Last price (9/30/11): $5.93
Shares: 4200
% of sector: 16.92%
% of portfolio: 1.99%
KeyBank operates under the holding group KeyCorp, headquartered in Cleveland, and provides
banking services to over 15 states in the east and Midwest. KEY has had lots of trouble dealing
with their net charge-offs and has caused their stock to drop significantly. While they maintain
decent asset quality and high customer service levels, they will need to address their bad debt
problems if they want to maintain a positive bottom-line.
Ticker
Company Name
cb equity
Chubb Corp/The
afl equity
Aflac Inc
Price
Market Cap (in millions) Price/Earnings Price/Book ROE
Beta
0.79
$ 67.78 $ 18,847.70
12.28 $ 1.21
13.95%
1.37
$ 44.87 $ 20,944.76
7.26 $ 1.65
24.07%
Aflac (AFL)
Last price (9/30/11): $34.95
Shares: 250
% of sector: 5.94%
% of portfolio: 0.70%
AFLAC Inc. is an insurance group based out of Columbus, Georgia that deals primarily in
accident and health insurance. Due to Japan’s environmental crisis in March, AFL’s stock price
has dropped but they are beginning to rebound. With 75% of company revenues coming from
Japan, they suffered only one quarter of net income decline and are now back on track. The
reason the fund owns AFL is because of their ability to control their side of the market and post
positive returns.
Chubb Corp. (CB)
Last price (9/30/11): $59.99
Shares: 500
% of sector: 20.38%
% of portfolio: 2.39%
43 | X S E I F S e m i -­‐ A n n u a l R e p o r t The Chubb Corp. is an insurance company based out of Warren, New Jersey focused mainly on
property and casualty insurance. CB’s stock is one that I believe to have even more growth
potential than it has already shown since the fund purchased the stock. They have faced major
bottom-line issues because of hurricane Irene, causing their pretax catastrophe cost to rise from
$58 million to $420 million. CB is a company that could rebound majorly from late 2011 and
outperform in 2012. The fund maintains a position here because they have a strong global
outreach, their advancement in technology, and its conservative client portfolio.
Changes in Sector Holdings
-Sold 800 shares of WFC on 5/10/11
-Sold 500 shares of USB on 5/10/11
-Purchased 780 shares of JPM on 5/10/11
Prospects
Wells Fargo & Company (WFC)
Wells Fargo, one of the largest banks in the U.S., has always been a bank that provides
dependability to the stock holder and pays out a high dividend. They are on the watch list
because in the current financial market a good, stable stock is what might be the safest option.
They have a low debt position compared to their peers and have dealt with recent government
regulations extremely well. Being able to manage liquidity well has been very tough for banks,
but WFC has been able to do it better than almost any other bank, despite their European
exposure.
ETF
Another possibility for the financial sector at this time could be an ETF. This would provide
much more security and a more reliable return in a time when that is seldom within the sector.
An ETF would bring much more diversity, especially because it covers a wide spectrum of
different financial securities. As far as screening goes for the ETF, one that has the least amount
of European exposure seems like the best place to start. This one quality has a direct
relationship with returns these days so possibly an ETF based in a non-European country would
be the best route to take.
44 | X S E I F S e m i -­‐ A n n u a l R e p o r t Sector Breakdown
Diversified Financial & Regional Banks
Just when things started to look better for the financials and regional banks, our economy was
hit with yet another financial crisis. Over the summer, Greece’s debt woes along with some other
European nations put the global economy into a downward spiral. With a good amount of the
debt in Europe tied to the U.S., our large banks suffered greatly. With most major banks already
in huge debt trouble, this catastrophe did not help. Companies are struggling to find ways to
reduce their risk exposure and get the financial sector back to a stable state. For this to happen,
management needs to step in so they can avoid future loan issues and improve credit quality.
Another main issue along with European economic trouble has been government regulation.
With banks now being hit with capital regulations there has been much more pressure on them
to meet these requirements and adjust their systems to do so. The Dodd-Frank Act has been the
main driver in this area because the government does not want to see a crisis like in 2008.
Different amendments to this act have further trouble banks, both big and small. All of these
policies together have strained financials and caused excess costs to meet these capital
requirements.
Insurance
The insurance market has been a subsector in the financial field that has had high volatility in
recent quarters. With environmental disasters across the globe and the state of our current
housing market, certain insurance companies have taken significant losses in the second and
third quarters. Life insurance agencies have suffered the most in the recent quarter due to the
Japan environmental crisis. Many U.S. companies in the insurance field are subject to risk in
Japan and China so this was a major setback for them. Both of our holdings in this area (CB &
AFL) have done well to avoid this issue, unlike some insurers were able to do.
The housing insurers have fared much worse than other insurers, though, due to the stillpresent after-effects of the 2008 housing bubble burst. There is a long chain connecting the
numerous reasons for the bad performance from stocks that deal in this area. Much of it starts
with the fact that unemployment is so high and that contributes majorly to the lack of consumer
spending. This in turn lowers the amount that people can borrow and thus affects the housing
market still. President Obama’s housing plan could have some effect on this market, but no
results have been seen yet.
Analyst Future Outlook
Looking forward, I think that good things are coming for the financial market for the rest of 2011
and early 2012. Banks are starting to become more and more regulated with time and this is
going to make them safer in the long-run. The European financial crisis has wound down since
45 | X S E I F S e m i -­‐ A n n u a l R e p o r t its start, though it is not completely over yet. Once stability can be reached overseas our markets
will increase significantly and go back to the progress it was making before the summer. A key
aspect for banks is to decrease their write-offs as much as possible. Banks losses have been
coming mainly from expose to bad debt on all levels of money lending. Banks need to use the
liquidity requirements of Basel III and Dodd-Frank to leverage themselves from the risk of bad
debt so they can gain the credit quality needed in a good economic environment. If banks can
manage their risk more efficiently, which I believe they will, I can see banks making a big
turnaround in early 2012.
46 | X S E I F S e m i -­‐ A n n u a l R e p o r t HEALTH CARE By Jaclyn O’Driscoll
Sector Allocation Recommendation:
Underweight
Current Sector Weight in Portfolio
9.72%
Current Sector Weight in Benchmark
11.09%
Benchmark Weight ± 50%
5.54-16.63%
Sector Stocks in Portfolio
5
Sector Stocks in Benchmark
45
Portfolio Sector Weighted Average Beta
0.78
Benchmark Sector Weighted Average Beta
1.06
Sector Summary
Below is a table with our current holdings in the health care sector. Throughout the report I will expand
on these stocks, strengths and weaknesses, and my outlook for the future. As of September 30th, we
currently hold 5 securities in this sector. The table below shows these securities with measures depicting
each securities risk, efficiency, and expected growth. The stocks that we currently hold cover the areas of
pharmaceuticals, managed care, and medical products and supplies.
Stocks in Portfolio
Company Name
Johnson & Johnson
Express Scripts
Abbott Laboratories
UnitedHealth Group Inc.
Teva Pharmaceuticals
Median
Total
Ticker Quantity Price (9/30) Market Cap (Bill)
JNJ
400
$63.69
73.58
ESRX 400
$37.07
22
ABT
500
$51.14
83.08
UNH
750
$46.12
48.59
TEVA 575
$37.22
38.52
48.59
Beta Current P/E Projected EPS EBITDA Margin % of Sector % of Portfolio
0.62
13.09
0.09
0.31
20.91%
2.03%
0.94
17.46
0.43
0.06
12.17%
1.18%
0.63
11.62
-0.20
0.24
20.98%
2.04%
0.96
10.15
0.27
0.09
28.38%
2.76%
0.74
12.2
0.62
0.30
17.56%
1.71%
0.74
12.2
0.27
0.24
20.91%
2.03%
100.00%
9.72%
47 | X S E I F S e m i -­‐ A n n u a l R e p o r t Comparative Returns
Health Care Index vs. S&P 500
*Bloomberg only has historic data on SPXHC index starting in 05/31/11.
Strengths and Weaknesses
Strengths
The strengths of this sector are the equity’s low betas, and the high paying dividends. The low
beta is attributed to the stability of the health care market. As more baby boomers are entering
retirement age, these keeps health care companies are able to see large growth and stability in
the future. Additionally the health care needs of Americans are continuing to grow due to the
magnitude of health problems individuals are being diagnosed with. Another strength of this
sector is the high dividend payout. Many of the established and secure companies have been
rewarding their investors with high dividends, and consistent dividend growth. An example of
this is Johnson and Johnson has been increasing their dividend for the past 49 years, and also
has one of the highest paying dividends in the sector. I see this as strength for this sector,
because a high dividend will help get us through with the stocks are not performing as well.
Weakness
The major weakness of this sector is the uncertainty of health care reform legislation. This
summer there were several rulings in many states regarding the legality of the bill. This has
raised concerns about the constitutionality of it. The U.S. Justice Department and the Obama
administration have decided to bring the bill to the Supreme Court this year, in the hopes that
this will finally settle the debate and mixed rulings. In October the Court will decided on
48 | X S E I F S e m i -­‐ A n n u a l R e p o r t whether or not they will be hearing the case in their upcoming session. If they decide to hear to
case, which is considered likely due to its importance, the ruling will not come out until June of
2012. This will then have a major impact on the presidential election in November, and could
completely sway the votes of Americans.
Another weakness of this sector is possibility of law suits against the malfunction of medical
devices, or of negative effects from pharmaceuticals drugs. This could cost the companies
millions in lawyer’s fees, in additional to any settlement amounts that they may have to pay out.
Also negative press from the litigation could negatively affect sales for a particular drug.
Additionally, if any of the issues deal with a manufacturing problem then there will be an
additional cost to replace or fix the equipment. This also would have a negative effect on sales
and EBIT, due to the time and costs that it takes to fix the manufacturing problem.
Sector Holding Analysis
The fund currently holds 5 stocks in the Health Care sector. These sticks are Johnson &
Johnson, Express Scripts, Abbott Laboratories, Teva Pharmaceuticals, and UnitedHealth Group.
Below is a brief description of our current holdings.
Johnson & Johnson (JNJ)
Price: $63.69
Shares: 400
Percentage of Portfolio: 2.03%
Percentage of Sector: 20.91%
Johnson and Johnson is one of the largest holdings in the health care sector portfolio, and is the
largest health care company in the index based on market cap. The company and its subsidiaries
are engaged in the research and development, manufacture and sale of a range of products in
the health care field. This company is a strong hold based on their stability and their high
dividend. JNJ has been able to steadily increase its dividend for the past 49 years. They also are
only one of four publicly traded companies with an AAA credit rating, which indicates that this
security is as reliable of a holding as a U.S. government treasury. They also currently have the
lowest beta in this sector, which is due to their diverse lines of products and businesses.
Express Scripts (ESRX)
Price: $37.07
Shares: 400
Percentage of Portfolio: 1.18%
Percentage of Sector: 12.17%
49 | X S E I F S e m i -­‐ A n n u a l R e p o r t The company is a full service pharmacy benefits management and specialty managed-care
company operating in North America. The company’s customers include insurance carriers,
third party administrators, employers, managed care organizations, and union-sponsored
benefit plans. Their main driver of business is their pharmacy benefits management, which has
grown on average for the past two year by 49.95%. Since the company is only limited to the U.S.,
there is some distress that their growth will begin to slow down. However the company is
looking into acquiring Medco Health Solutions, which is also in the pharmacy benefit
management business. The company hopes that this will help increase efficiency in their full
service pharmacy business, and it fits within the company’s core competencies. The company
has shown a history of successful acquisition of companies, and paying down its debt with solid
free cash flow generation.
Abbott Laboratories (ABT)
Price: $54.14
Shares: 500
Percentage of Portfolio: 2.04%
Percentage of Sector: 20.98%
Abbot Laboratories is our smallest holding in the health care sector. The company is involved in
four areas: pharmaceutical products, diagnostic products, nutritional products, and vascular
products. They discover, develop, manufacture, and sell their products and services worldwide.
On October 18th the company announced that they will separate into two publicly traded
companies next year. One company will be focused on diagnostics and medical devices, which
will retain the name Abbot. The other company will be focused on pharmaceuticals, which has
yet to be named, and will be lead by a long time Abbott official. Currently the company’s
pharmaceutical business is their revenue drive, with a two year average growth of 9.67%. The
company is currently experiencing growth in their Japan and developing countries markets.
UnitedHealth Group Inc. (UNH)
Price: $46.12
Shares: 750
Percentage of Portfolio: 2.76%
Percentage of Sector: 28.38%
UnitedHealth Group Inc. is our largest holding in the health care sector. The company works
with the health care industry as a whole to expand the access to high quality care for individuals
across the country. They also service the needs of older Americans through specialized care
services, and provide information and research to providers and payers. The four main drivers
50 | X S E I F S e m i -­‐ A n n u a l R e p o r t of their business are their health benefits, OptumHealth, Ingenix, and Prescription Solutions.
Their main revenue driver is their health care services and benefits segment.
UNH was bought on May 5th, and became the fifth holding on in this sector. The main reason for
its purchase was the company’s size. They currently have 77 million customers, which are spread
out throughout the country. This lowers their risk for region-specific disasters and changes in
state regulations. Another reason for its purchase is their strong position within the managed
care segment. Since they have a strong presence already in the market, the company is
positioned to capture gains as more Americans are entering into retirement. Additionally, this
company should be closely monitored, especially since the health care reform legislation, and
Medicare and Medicade will greatly affect the company’s future revenues.
Teva Pharmaceuticals, Industries (TEVA)
Price: $37.22
Shares: 575
Percentage of Portfolio: 1.71%
Percentage of Sector: 17.56%
Teva Pharmaceuticals is a global pharmaceutical company, which develops, manufactures, and
markets generic pharmaceuticals and active pharmaceutical ingredients. The company is
currently headquartered in Israel. The company has seen sales decline in the U.S. by 15% for
2010, however they had an increase in sales in developing countries of 22%. A reason for the
decline in sales in the U.S. do is to quality issues, which have slowed down production at their
Irvine, CA plant. The company is currently working with the FDA to get quality back up to
production level. TEVA is also currently in the middle of two major lawsuits. They have recently
settled two previous lawsuits in the past year, which has had a negative impact on their G&A
expenses.
Changes in Sector Holdings
-05/05/11 Purchased 750 shares of UnitedHealth Group, Inc. for $50.05
Prospects
Bristol-Meyers Squibb Co. (BYM)
Bristol-Myers Squibb Co. is a global biopharmaceutical company. The company license,
manufactures, markets, distributes, and sells pharmaceutical products. They have several drugs
51 | X S E I F S e m i -­‐ A n n u a l R e p o r t that have been approved, or in Phase III, which should replace a majority of the lost revenue
from the upcoming expiration of patents. This includes the company’s partnership with Eli Lilly
on its drug Necitumumab, which is also in Phase III. Recently the company has met its $2.5
billion cost savings and cost avoidance goal for the 2010 year. This is due to management
cutting back on marketing selling and administrative expenses, and simplifying process and
services. Additionally this stock pays one of the highest dividends in the pharmaceutical sector
(4.52%).
Sector Breakdown
Pharmaceuticals (Abbott Labs, Teva Pharm., Express Scripts)
There are a large number of patents for major drugs that are set to expire in the within
the coming year, which will present an unprecedented loss for Big Pharma. The biggest
companies to get hit will be Pfizer, Elli Lilly, and Johnson &Johnson. As a reaction to this Big
Pharma has been in the process of an expense-reduction program, in which they are realigning
their cost structures to anticipate lower sales. Finally, this subsector is looking to expand into
biotechnology for future potential product protection and revenues.
Facilities
This sub-sector has faced a challenging environment in recent years. Profits are being
pressured by the decrease in elective procedures, unemployment, and uninsured patients. With
the health care reform issue being debated, and the bill being debated by the Supreme Court,
this sub-sector is looking to have gains in the long term.
Managed Care (UnitedHealth Group)
This sub-sector could potentially be impacted the most by the health care reform bill.
Additionally, unemployment rates and the rise of uninsured people have created an obstacle for
MCOs. The reform bill will be creating more restrictions on the way MCOs operate, which could
potentially hurt the way they do business. A response to this future hit is that MCOs are
reducing their SG&A costs as a percentage of premiums and management fees.
Products and Supplies (Johnson and Johnson)
The health care reform bill will have a major impact on this sub-sector, providing that it
gets through the Supreme Court. The biggest area to be hit with this will be with the medical
device companies, which have been relying on inpatient numbers at hospitals. However, the
medical device companies have been making up some of their losses in the emerging markets.
Long term growth looks good for this sub-sector because of aging populations, expanding
middle class in emerging markets, and increased obesity.
52 | X S E I F S e m i -­‐ A n n u a l R e p o r t Analyst Future Outlook
Looking forward I plan to keep this sector underweighted due to the uncertainty of how this
sector will be impacted by health care legislation. The bill has already been challenged in several
states, and has produced several different rulings. The case for the president’s health care
reform bill will be reviewed by the Supreme Court on November 10th, which will indicate if the
court will allow for the case to be presented in their upcoming term. If they accept the case,
which is considered highly likely considering its importance, then they will not come out with
their ruling until June of 2012. This puts a lot of uncertainty on the companies in this sector,
especially since all of our holdings will be impacted in some way by the ruling. Therefore I see
keeping the sector underweight the entire year will be the best play.
In addition to this I also want to closely monitor Abbott Laboratories, which will be splitting into
two companies in the upcoming year. From there I will need to decide how these two companies
fit into our overall strategy for the fund, and into my strategy for this sector. I hope to sell off
some of our holdings in TEVA, and find another opportunity in another generic or band name
pharmaceutical company. This is because TEVA has experience some major setbacks in the past
year, which could indicate bad management decisions being made.
53 | X S E I F S e m i -­‐ A n n u a l R e p o r t INDUSTRIALS By Ryan Alleman and Ben Lawrence
Sector Allocation Recommendation:
Overweight
Sector Weight in Portfolio as of
11.11%
Sector Weight in Benchmark as of
10.09%
Benchmark Weight ± 50%
5.04% – 15.13%
Sector Stocks in Portfolio
5
Sector Stocks in Benchmark
60
Portfolio Sector Beta
.97
Benchmark Sector Beta
1.12
Sector Summary
Since March 31, 2011, both the S&P 500 and the Industrials Sector have seen losses in returns.
The sector as whole has been more volatile in performance against the index, underperforming
throughout the period. While the sector’s performance has been unimpressive, there are reasons
to believe it will continue to outperform in the long term.
Comparative Returns
Industrials Index vs. S&P 500
54 | X S E I F S e m i -­‐ A n n u a l R e p o r t Sector Holding Analysis
As of September 30, 2011, the fund owned five industrials stocks (CSX, GE, FDX, ITW, JEC,)
whose holdings represented 11.11% of the fund’s market capitalization.
DCF INDUSTRIALS HOLDINGS as of SEPTEMBER 30, 2011
Company Name
Market
Capitalization
Total
Revenue
(LTM)
EBITDA
(LTM)
EBITDA
Margin
(LTM)
ROE
EV/EBITDA
(LTM)
P/E
(LTM)
Dividend
Yield (%)
Beta
CSX CORP
$22.85B
$11.61B
$4.42B
37.78%
11.54%
10.18
13.4
2.21%
1.24
FEDEX CORP
$26.02B
$40.37B
$4.58B
11.30%
21.27%
11.43
15.3
0.63%
1.11
GENERAL ELECTRIC
$173.74B
$145.68B
$26.01B
16.17%
10.27%
34.64
11.23
3.66%
1.15
ILLINOIS TOOL WORKS
$23.79B
$17.75B
$3.27B
18.31%
21.60%
10.98
13.45
2.93%
1.31
RR DONNELLY & SONS
$3.12B
$10.60B
$1.27B
12.50%
11.54%
8.02
6.55
6.25%
1.15
General Electric Company (NYSE:GE)
Close Price (9.30.2011): $15.22
Total Shares Owned: 1450
General Electric (GE) is one of the largest companies in America which is divided into 5
different business segments, including Energy Infrastructure, Technology Infrastructure, NBC
Universal, GE Capital and Home & Business Solutions. Incorporated in 1892, GE is
headquartered in Fairfield, Connecticut. While U.S. operations account for a large portion of
revenues, GE’s has a significant global presence – having operations in over 100 foreign
countries.
While being impacted by the recent economic recession – with revenues dropping 23.5% over
the past few years – and with most analyst forecasting around a 5% loss for the coming fiscal
year, GE shows promise in the future as a long-term buy. Currently undervalued, especially with
the current Japan crisis having an adverse affect on stock price, GE should build revenues by
nearly 15% (given a 5% decrease in 2011) over the coming 5 year – restoring them to historical
high’s. Much of this growth can be attributed to GE’s sell-off of their unprofitable Security
business segment (to United Technologies) and with their recent acquisitions of Dresser Inc.
(Energy) and Wellstream PLC (Oil & Gas). In the 3rd Quarter of 2011, GE saw operating earnings
of $3.4 billion – an 11% increase year-over-year.
55 | X S E I F S e m i -­‐ A n n u a l R e p o r t Due to these factors, as well as future federal funding in infrastructure and a general consensus
that the market is on the rebound from the recession, there is reason to believe that GE will
continue to grow in value.
CSX Corporation (NYSE:CSX)
Close Price (9.30.2011): $18.67
Total Shares Owned: 1950
CSX Corporation, together with its subsidiaries, provides rail-based transportation services in
North America. The company offers traditional rail service, and the transport of intermodal
containers and trailers. It provides integrated intermodal transportation services linking
customers to railroads, through trucks and terminals. The company also engages in the real
estate sale, leasing, acquisition, and management and development activities. As of December
25, 2009, it operated approximately 21,000 route mile rail network and 216,000 freight car fleet
in 23 states east of the Mississippi River, the District of Columbia, and the Canadian provinces
of Ontario and Quebec.
Total revenues for CSX topped at $11.26 million in 2010, up nearly 20% over the previous year.
This, coupled with the fact that efficiency has increased with the operating ratio dropping 3.8%
from the previous year, means overall more income to CSX. While management has done an
effective job, the heavy investment in infrastructure should help to drive both volume and
efficiency. For the 3rd Quarter of 2011, CSX announced record earnings of $464 million – an
increase of 19% year-over-year. Given these conditions, CSX has good prospects going into the
future as a long-term buy.
FedEx Corporation (NYSE:FDX)
Close Price (9.30.2011): $67.68
Total Shares Owned: 450
FedEx is the world’s largest express-delivery company and earns more than 60% of its revenue
from its express division. The firm’s 2 other segments, ground and freight, allow FedEx to
exploit its competitive advantage in parcel delivery as it can handle most types of shipping. The
strength of the space’s barrier to entry allows for few competitors, including the withdrawal of
DHL, allowing FedEx the opportunity to be a greater part of their clients’ operations.
Additionally, FedEx Office provides document production technology, internet access, Webbased printing, and shipping services to customers from brick-and-mortar stores.
56 | X S E I F S e m i -­‐ A n n u a l R e p o r t Operating income almost tripled from 2009’s $747mm to an impressive $1,998mm in 2010 and
the operating margin increased from 2.1% to 5.75%. Through the end of 2011, FedEx is planning
on combining two of its freight segments and projects the new structure will require 100 fewer
facilities and 1,700 fewer employees. In June, FedEx reported fiscal fourth quarter earnings of
$10.55 billion – an increase of 12% year-over-year. More than likely, this move will serve to
increase efficiency and lower costs in the long run but we don’t believe it will provide any shortterm gains.
R.R. Donnelly & Sons Company (NASDAQ: RRD)
Close Price (9.30.2011): $14.12
Total Shares Owned: 535
Founded more than 146 years ago, RR Donnelley and Sons Company is the world’s largest
commercial printer. They currently print and bind a major share of prevalent national
publisher’s such as Time, Newsweek, and T.V. Guide. Beyond these publications, they also print
and bind for telephone directories, encyclopedias, and school and religious books. Beyond their
printing and publishing products, they also house Internet-based capabilities to provide premedia, logistics, and business outsourcing products and services to clients in both the public and
private sectors. Besides extensive operations in the United States, which accounts for roughly
75% of the company’s net sales in 2010, RR Donnelley also has extensive international presence
in Asia, Europe, Latin America, and Canada.
In the near future, we believe RRD will continue to experience growth in value through its
effective management within a struggling area of the sector (printing & publishing). For the 3rd
Quarter of 2011, RRD reported earnings of $2.7 billion – an 8% increase year-over-year. RRD
has shown opportunity to grow its market share, particularly through new technology such as its
acquisition of Helium.
Illinois Tool Works, Inc. (NYSE: ITW)
Close Price (9.30.2011): $49.23
Total Shares Owned: 1030
Illinois Tool Works is a diversified manufacturer of engineered products and specialty systems.
Operating in more than 6 lines of business, the company has significant exposure to
transportation, electronics, power systems, construction and fluids industries. Based in
Glenview Illinois, the company currently has more than 20,000 patents or pending patent
applications; as a result, the company consistently ranks as one of the top U.S. patent holders.
2010 Revenues totaled more than $15 billion. Globally, ITW employs more than 59,000 people
through its network of more than 200 companies.
57 | X S E I F S e m i -­‐ A n n u a l R e p o r t ITW can expect to see significant top-line growth due to their exposure to emerging markets as
well as their emphasis on future mergers & acquisitions activity. Additionally, the company has
recently expressed its renewed emphasis on generating higher levels of free cash flow while
maintain a strong dividend yield. As emerging markets continue to expand and as established
markets rebound ITW is in position to take advantage of future growth. For the 3rd Quarter of
2011, ITW reported year-over-year earnings growth of 20%.
Changes in Sector Holdings
During the past six months, the industrials sector has seen two primary changes within the fund.
DCF sold off our position in Jacobs Engineering in May. In September DCF also sold our
summer holding of a Spyder ETF. The proceeds from the Spyder sale resulted in one buy within
the sector:
5/10/2011 – Jacobs Engineering (JEC) – 350 shares at $46.99/share
9/6/2011 – RR Donnelly & Sons (RRD) – 535 shares at $14.79/share
Sector Breakdown
The Industrials sector is very broad and includes companies whose businesses are dominated by
one of the following activities: the manufacture and distribution of capital goods (aerospace &
defense, construction, engineering & building products, electrical equipment, industrial
machinery;) the provision of professional and commercial services and supplies (printing,
employment, environmental and office services;) and the provision of transportation services
(airlines, couriers, marine, road & rail and transportation infrastructure;) and industrials
conglomerates.
Industrial Conglomerates
Within Industrial Conglomerates, DCF currently owns General Electric. Diversified
organizations such as General Electric are broadly exposed to the national and global
economies. As a result, they tend to succeed during time of economic expansion and remain
static during times of economic decline. Due to their size, Industrial Conglomerates tend to have
strong exposure to emerging markets. As a result, these conglomerates can take advantage of
growth anywhere in the global economy. With the recent political turmoil in Europe, the growth
of emerging markets as begun to slow, resulting in a more static level for Industrial
Conglomerates. With an anticipated resolution to the problems in Greece, it is expected that
Industrial Conglomerates will continue to succeed. As a result, we will continue to focus on this
area of the sector.
58 | X S E I F S e m i -­‐ A n n u a l R e p o r t Transportation (Air Freight, Logistics, Airlines, Marine, Transportation Infrastructure)
Within Transportation, DCF currently owns CSX, and FedEx. Transportation – in a strong way
– is linked to the volatility of energy prices. When energy prices are low, as they have been
recently, air and over-the-road logistics become preferred methods of transportation due to
their speed. When energy prices are high, as they appear to be trending, rail transportation
becomes the preferred method of transportation due to its fuel efficiency. Other traditional
transportation methods – such as water transportation – are largely unaffected by oil prices. In
order to take advantage of trends in the oil market – which appear to going higher – we would
prefer to stay away from air and over-the-road transportation services while focusing on rail and
water transportation services.
Construction (Building Products, Construction & Engineering, Electrical Equipment,
Machinery)
Within Construction & Machinery, DCF currently owns Illinois Tool Works. With current
stimulus being directed towards infrastructure projects, as well as the long-term need for
infrastructure improvements, we expect to see continued growth in this area of the sector. While
new construction of both residential and commercial real estate continues to be low, it is
possible that we are nearing a bottom in these markets and that continued growth will
Aerospace & Defense
DCF does not currently have any positions within Aerospace & Defense. With the scaling back of
the wars in Iraq and Afghanistan, as well as budget pressure in the United States, it is
increasingly likely that spending in the Aerospace & Defense sectors will decrease. As a result,
we will not prioritize firms in the Aerospace & Defense industries at this time.
Commercial Services
Within Commercial Services, DCF currently owns RR Donnelley. Commercial Services has been
another area that has been impacted by a decrease in new construction, as some of the
peripherals of new construction (i.e. fire systems, security systems, etc.) have been less utilized.
In addition, with print media heading more and more in a digital direction, print specialists such
as RR Donnelley are being challenged to diversify. Given these current pressures on Commercial
Services, this is not an area of the sector in which we will concentrate. However, with a possible
return of new construction, opportunities could arise for some of the peripheral construction
firms as well. This could be an opportunity to gain expose to construction without investing in
the construction sector directly.
59 | X S E I F S e m i -­‐ A n n u a l R e p o r t Professional Services
DCF does not currently have any positions within Professional Services. Professional Services
has been an area that has been bolstered by the economic downturn. As firms began to seek
ways to cut spending, many of them sought opportunities to outsource non-essential tasks to
law firms, accounting firms and placement services. If unemployment rebounds in the near
future, it is possible that this area of the sector will struggle. As a result, it is not an area in which
we will concentrate.
Strengths and Weaknesses
Strengths
Several factors should continue to demonstrate strength within the industrials sector:
As the global economy continues to emerge from the recent recession, many firms are prepared
to begin new capital expenditure projects which they may have previously put on hold.
As a result, we should see increased opportunities for manufacturers of products such as
engines, turbines, heavy industrial equipment, agricultural machinery, trucks, tractors, and
other highly priced commodities.
To help jump start the national economy, the federal government continues to propose new
forms of economic stimulus.
A key focus of the stimulus is our national infrastructure, with proposed projects such as
improving our interstate and railroad systems and encouraging new forms of mass transit.
These products should result in increased opportunity for manufacturers of construction and
heavy industrial equipment, as well as other industrials firms that focus on infrastructure
related activities.
Emerging markets are expected to spend roughly $6.3 trillion on infrastructure projects over the
next three years.
China is expected to spend roughly $23 Billion on major infrastructure projects, some of which
have already begun. This spending will increase opportunity for conglomerate companies within
the industrials sector who specialize in construction, heavy industrial equipment, transit power,
and other infrastructure activities.
Weaknesses
A number of factors continue to demonstrate areas of weaknesses within the industrials sector:
60 | X S E I F S e m i -­‐ A n n u a l R e p o r t With the recent debt crisis within the United States, the federal government is currently focused
on deficit reduction.
Some aerospace firms and heavy machinery firms which supply defense equipment could be
disproportionally impacted by these proposed spending cuts.
As global energy prices continue to rise, several firms within industrials could be negatively
impacted.
According to a recent report by the U.S. Energy Information Administration, industrials firms
and equipment consume roughly one half the worlds’ total delivered energy.
With the increase in commodity prices, industrials firms will likely continue to feel strain both
on top line growth as well as their margins.
In addition to manufacturing equipment that is highly dependent on other industries which
focus on raw materials (i.e. mining, metals manufacturing, etc.) many industrials firms
manufacture equipment which contains large amounts of commodities such as heavy metals. As
a result, the industry which the sector targets is negatively impacted by commodity prices, and
the sector itself is impacted by commodity prices.
Screening and Strategy
After identifying companies which align with the fund’s prospectus, industrials uses multiple
processes to identify undervalued firms. One possible next step is to value companies based off
of their Price to Earrings (P/E) ratio. A low P/E target relative to a particular industry shows
that a company may be possibly undervalued.
Another potential starting point is to utilize our sector’s outlook to focus on areas of the sector
that are well established for growth. By focusing on these firms, the analysts are able to maintain
our strategy of using a bottom up approach to identify undervalued firms, while also prioritizing
areas of the sector that are poised for future opportunities.
Once potentially undervalued firms have been identified, a discounted cash flow (DCF) and
relative valuation is performed on the prospect companies to see whether they are truly
undervalued in the market. This, combined with qualitative analysis, is then implemented in
either recommending a sell/buy/hold position to the other fund analysts and managers. Within
Industrials, there are currently 60 firms in the S&P 500.
61 | X S E I F S e m i -­‐ A n n u a l R e p o r t Prospects
Based off the our screening strategy, alongside some preliminary qualitative analysis, the
following represent prospects with the highest potential for this sector, sorted by preference of
purchase.
Caterpillar (NYSE: CAT)
Caterpillar is the world's leading manufacturer of construction and mining equipment, diesel
and natural gas engines, industrial gas turbines and diesel-electric locomotives. 2010 Revenues
totaled more than $42 billion. Caterpillar is based in Illinois and has been in operation for more
than 85 years. CAT operates 6 distinct business lines: Machinery, Engines, Defense Products,
Electronics and Agriculture Products, as well as a financing arm. Currently the firms
manufactures their products 110 facilities worldwide, roughly half of which are in the United
States. Through this manufacturing, CAT is able to distribute their products in 200 countries,
with a network of 220 worldwide dealers.
Eaton Corporation (NYSE:ETN)
Eaton provides power management solutions to industrial customers. The firm sells to both
original equipment manufacturers and aftermarket consumers. More than 50% of its sales come
from outside of the U.S. This gives the company the ability to capitalize on emerging markets,
such as the growing auto market in China.
3M Company (NYSE:MMM)
3M is a diversified manufacturer with a global presence in over 60 countries. Its core business
segments include: industrial and transportation, display and graphics, health care, consumer
and office, electro and communications, and safety, security and protection. Recently 3M has
had much acquisition activity, taking in companies like Cogent, Winterhur Technologies,
Arizant, and Nida-Core.
Analyst Future Outlook
Though the industrials sector has been underperforming the S&P 500 index, we believe that it
has the potential to outperform the index in the near future. Increased spending in
infrastructure, as well as the continued growth of emerging markets, will increase revenues for
companies with operations both domestically and abroad. As a result, we are comfortable taking
an overweight position in the Industrials sector while continuing our emphasis on security
selection.
62 | X S E I F S e m i -­‐ A n n u a l R e p o r t INFORMATION TECHNOLOGY By Curtis May and Phillip Weickert
Spring 3.31.2011
Fall 9.30.2011
Overweight
Overweight
Sector W eight in Portfolio
25.10%
28.47%
Sector W eight in Benchmark
18.50%
19.68%
Benchmark W eight ± 50%
9.2% -­‐ 27.8%
9.84% -­‐ 29.52%
Sector Stocks in Portfolio
7
7
Sector Stocks in Benchmark
75
75
Portfolio Sector Beta
0.98
1.03
Benchmark Sector Beta
1.01
1.12
Sector Allocation Recommendation
Sector Summary
As of September 30, 2011, the fund owned seven information technology stocks: Visa, Apple,
Cognizant Tech Microsoft, Google, Intel, and Qualcomm.
Name
Subsector
Visa Inc
Apple Inc
Cognizant Tech
Microsoft Corp
Google Inc
Intel Corp
QUALCOMM Inc
IT Services
Electronic Equip
IT Services
Software
Internet Software
Semiconductors
Communication Equip
Percentage of total Portfolio
Percentage of IT Stocks in Portfolio
6.39%
6.08%
22.64%
21.54%
4.25%
15.05%
4.17%
2.46%
2.55%
2.33%
14.76%
8.73%
9.04%
8.24%
Market Cap
Beta
$59,268.96 Million 0.96
$374,822.84 Million
1.06
$22,242.23 Million 1.13
$208,535.03 Million 0.94
$166,074.77 Million 1.05
$116,245.52 Million 1.02
$84,474.09 Million 1.06
Total Return 4/1/2011 -­‐ 9/30/2011
16.864%
10.669%
-­‐23.917%
-­‐1.073%
-­‐12.971%
10.114%
-­‐9.978%
The S& P’s 500 Information Technology Index, has fallen 9 percent at the end of September,
compared with a 14 percent decline in the S&P 500 Index. Since the IT sector has outperformed
the S&P 500, we decided to keep its overweighting within the portfolio. Three of the top five
performers over the last six months for the portfolio were in the IT sector. This is attributable to
the securities selection in our sector.
63 | X S E I F S e m i -­‐ A n n u a l R e p o r t It is unusual for a cyclical industry to outperform the market when economic growth declines. A
possible reason for this is less downside risk in the technology sector than other cyclical sectors
because of stronger balance sheets. Large cash balances on IT companies’ balance sheets may
be a leading buffer for the cyclical risk. Some companies, such as Google and Microsoft with
their purchases of Motorola Mobility and Skype respectively, are using their cash for mergers
and acquisition to try and continue to grow, even in a slowing economy. We expect IT stocks to
continue this trend in the future.
Comparative Returns
Information Technology Index vs. S&P 500
The graph above is representative of the daily return of the Info Tech Index in the S&P 500 and
our benchmark, the S&P 500 index. Through the period 04/01/2011 to 09/30/2011, the Info
Tech Index closely followed the S&P for the last six months, but outperformed the S&P during
the month of September.
64 | X S E I F S e m i -­‐ A n n u a l R e p o r t Relative Analysis
The list on the next page represents the 75 Companies in the Information Technology Sector of
the S&P 500, sorted by market capitalization. Current holdings are shaded.
Nam e
M ar k e t Cap:Q
APPLE INC
$
375,706,681,344
MICROSOFT CORP
$
IBM
$
GOOGLE INC-CL A
P/E:Q
Be ta:M -6
14.61
0.83
209,324,900,352
9.22
206,104,952,832
13.49
$
165,482,872,832
ORACLE CORP
$
INTEL CORP
Total Re tur n:M -6
EBITDA M r gn:Q
EPS:Q
14.49
32.89
7.13
0.87
2.03
42.25
0.68
0.82
10.22
23.26
3.23
17.56
0.94
11.26
36.20
8.44
141,781,565,440
15.17
1.14
-7.31
44.40
0.36
$
119,071,047,680
8.93
0.82
2.88
44.48
0.67
CISCO SYSTEMS
$
86,796,951,552
12.28
1.03
4.00
25.36
0.22
QUALCOMM INC
$
84,537,491,456
17.58
1.08
1.58
38.74
0.63
HEWLETT-PACKARD
$
70,410,338,304
7.85
1.06
-33.54
14.34
0.94
VISA INC-CLASS A
$
69,604,638,720
17.14
0.98
16.56
62.59
1.28
EMC CORP/MASS
$
42,818,699,264
19.26
1.04
-9.86
24.39
0.29
MASTERCARD INC-A
$
40,256,688,128
17.76
1.22
27.64
54.17
5.65
EBAY INC
$
38,061,121,536
19.79
1.22
-0.91
28.52
0.38
ACCENTURE PLC-A
$
37,019,938,816
15.76
1.06
5.39
14.57
0.95
TEXAS INSTRUMENT
$
30,451,619,840
10.79
0.94
-7.82
34.64
0.52
DELL INC
$
29,784,160,256
8.41
1.10
-3.03
8.80
0.48
AUTOMATIC DATA
$
23,088,300,032
18.42
0.87
-3.58
21.60
0.62
SALESFORCE.COM
$
19,608,205,312
803.94
1.20
-0.26
10.38
-0.03
CORNING INC
$
19,392,839,680
6.57
1.29
-28.27
35.21
0.52
COGNIZANT TECH-A
$
19,039,481,856
22.97
1.20
-8.32
20.64
0.75
NETAPP INC
$
17,530,128,384
20.31
1.14
-17.83
18.42
0.38
BROADCOM CORP-A
$
17,308,489,728
17.90
1.05
3.85
17.04
0.50
YAHOO! INC
$
16,628,599,808
15.87
1.04
-16.26
29.19
0.23
APPLIED MATERIAL
$
16,237,760,512
8.56
1.03
-16.62
26.13
0.36
INTUIT INC
$
14,037,879,808
22.03
0.96
-1.21
33.19
-0.19
MOTOROLA SOLUTIO
$
13,638,450,176
18.14
0.91
3.30
12.45
0.38
SYMANTEC CORP
$
12,015,754,240
16.80
1.05
-13.10
26.86
0.24
TE CONNECTIVITY
$
11,925,088,256
9.23
1.08
-0.35
17.35
0.76
ADOBE SYS INC
$
11,901,264,896
13.72
1.05
-10.33
34.84
0.39
MOTOROLA MOBILIT
$
11,315,109,888
0.82
61.97
2.19
-0.11
ANALOG DEVICES
$
10,300,664,832
11.94
0.94
-6.50
40.75
0.73
CITRIX SYSTEMS
$
10,267,289,600
30.46
1.33
-7.89
25.78
0.49
ALTERA CORP
$
10,116,557,824
12.03
1.07
-17.24
45.47
0.58
PAYCHEX INC
$
9,777,552,384
18.35
0.90
-8.17
42.61
0.41
XEROX CORP
$
9,667,759,104
7.83
1.22
-15.56
13.58
0.23
SANDISK CORP
$
9,653,961,728
8.22
1.21
8.64
32.57
0.97
CA INC
$
9,499,524,096
11.76
0.99
-11.02
36.66
0.47
WESTERN UNION
$
9,466,039,296
9.68
0.99
-15.52
28.27
0.38
JUNIPER NETWORKS
$
9,199,165,440
17.26
1.32
-35.69
20.14
0.16
TERADATA CORP
$
9,009,098,752
25.13
1.15
5.39
23.20
0.52
NVIDIA CORP
$
8,349,549,568
16.08
1.37
-20.54
20.19
0.25
AUTODESK INC
$
7,871,567,360
32.15
1.33
-19.95
20.27
0.31
RED HAT INC
$
7,621,232,640
61.78
1.15
10.36
21.99
0.21
FIDELITY NATIONA
$
7,441,871,360
14.14
1.02
-23.37
29.12
0.45
XILINX INC
$
7,244,324,864
12.14
0.88
-5.42
33.84
0.48
FISERV INC
$
7,148,416,000
13.47
0.95
-6.13
31.22
0.90
AMPHENOL CORP-A
$
6,927,556,608
13.64
1.17
-12.75
22.52
0.80
ELECTRONIC ARTS
$
6,747,232,256
1.14
26.51
1.89
-1.03
BMC SOFTWARE INC
$
6,578,335,744
16.41
0.94
-26.70
35.67
0.66
KLA-TENCOR CORP
$
6,379,914,240
7.63
1.05
9.99
38.79
1.15
LINEAR TECH CORP
$
6,280,946,176
11.57
0.90
-2.77
54.18
0.47
WESTERN DIGITAL
$
6,018,480,128
7.35
1.13
-26.45
14.65
1.03
MICROCHIP TECH
$
5,936,068,096
15.18
0.90
-7.11
39.21
0.42
COMPUTER SCIENCE
$
5,921,564,672
7.81
1.19
-25.39
13.09
1.18
MICRON TECH
$
5,708,429,824
63.78
1.55
-45.16
32.54
-0.14
F5 NETWORKS
$
5,623,252,480
23.92
1.31
9.93
32.26
0.84
SAIC INC
$
5,482,259,968
11.06
0.93
-27.08
9.45
0.51
FIRST SOLAR INC
$
5,459,933,184
10.40
1.36
-60.74
30.06
2.28
ADV MICRO DEVICE
$
4,913,010,176
4.62
1.35
-35.49
11.66
0.13
VERISIGN INC
$
4,549,905,408
66.53
1.02
-1.66
50.15
FLIR SYSTEMS
$
4,001,236,480
16.48
1.12
-21.00
25.13
0.41
JDS UNIPHASE
$
3,878,279,936
26.95
1.80
-38.75
11.41
-0.03
HARRIS CORP
$
3,859,502,336
7.30
1.17
-20.74
19.01
1.01
AKAMAI TECHNOLOG
$
3,665,474,304
19.68
1.26
-13.19
39.95
0.23
MOLEX INC
$
3,580,989,952
11.32
1.29
-4.60
19.15
0.46
JABIL CIRCUIT
$
3,427,568,128
8.87
1.45
6.44
5.67
0.54
TOTAL SYS SERVS
$
3,261,733,888
15.82
0.91
7.48
26.63
0.30
LSI CORP
$
2,967,502,848
27.26
1.25
-14.21
14.72
0.05
LEXMARK INTL-A
$
2,142,208,640
5.68
1.08
4.84
15.47
0.87
TERADYNE INC
$
2,049,886,976
9.18
1.29
-8.30
28.24
0.30
NOVELLUS SYS
$
1,903,790,720
7.99
0.97
8.14
25.71
0.74
0.36
65 | X S E I F S e m i -­‐ A n n u a l R e p o r t COMPUWARE CORP
$
1,674,454,528
TELLABS INC
$
1,565,519,104
MEMC ELEC MATER
$
1,207,468,928
MONSTER WORLDWID
$
883,750,272
15.63
1.17
-23.17
20.20
0.10
1.27
-7.33
0.14
-0.38
13.79
1.64
-54.31
8.74
-0.41
12.38
1.67
-44.05
11.57
0.26
Strengths and Weaknesses
Strengths
The IT sector is a high growth industry. This offers many opportunities to find mispricings that
we can capitalize on. The IT also has significant room for growth in emerging markets such as
China and India. As stated in the sector summary, there are also many opportunities for mergers
and acquisitions in the IT sector, as many tech stocks are sitting on piles of cash. These high
amounts of liquidity have enabled tech companies throughout the sector to be resistant to recent
downturns in the economy. It also shows that more established companies with high cash
balances and mature growth rates can still offer opportunities for expanded growth.
Weaknesses
The IT sector is hard to value because it is a highly competitive industry. Since it is highly
competitive, litigation between tech companies is very common given the high amount of
intellectual property that seems to be infringed upon every year. Impending lawsuits are an
issue that needs to be kept in mind and monitored closely. Google, Apple, and Microsoft seem to
be constantly involved in legal proceedings. Another major weakness of the IT sector is that
roughly 60% of its revenues derive from foreign countries, the most of any sector. This offers a
substantial risk as it exposes the sector to the debt crisis on a large level. Since most of the stocks
in the IT sector are cyclical, they move with the market. With the market in a downturn,
investing in a sector such as Consumer Staples may make more sense to avoid the downturn of
the market. However, the IT sector did outperform the S&P for the month of September, and
prospects for growth remain high.
Future Planned Changes
IT makes up the largest portion of the portfolio with a 29.3% weighting and 4 stocks that
individually have a 3.5% weighting. Considering the size of this sector, the analysts allocate a
large portion of their time on evaluating current holdings at a deeper level. We plan to make the
following changes in our portfolio:
1. Rebalance share in Apple: To lock in gains realized over the past year and reduce the
company risk associated with a 6.08% weighting in one stock, we want to reduce the
weighting in Apple to 5.5%.
66 | X S E I F S e m i -­‐ A n n u a l R e p o r t 2. Rebalance share in Visa: To lock in gains realized over the past year and reduce the
company risk associated with a 6.39% weighting in one stock, we want to reduce the
weighting in Visa to 5.5% after further review.
Prospects
F5 Networks (FFIV)
F5 Networks (FFIV) is a technology company that offers hardware and software for networking,
WAN optimization, secure remote access and file virtualization, and other resources. It is
currently trading at 111.19, which is in the middle between its 52-week high of $145.76 and the
52-week low at $80.00.
Revenues for F5 Networks have shown a steady increase over the past several quarters, with the
last quarter coming in higher by 12.7%. In terms of valuations, the FFIV shows a price earnings
ratio of 23.92, well below its five-year average of 44.19, making it a good point to buy. The
company should also be able to improve on its 30% EBIT margin going forward as total
operating expenses have decreased by almost 8% over the last three years. F5 Networks should
continue to provide excellent returns with industry leading technology and solid market
position.
Sector Breakdown
Software
Security software is one product line that is seeing strong demand. Recent security breaches at
companies such as Epsilon Marketing is further pressuring an emphasis on security. The
implementation of cloud computing will also pressure an increase in network security as more
and more data is pushed through the internet.
Another area that will need some attention will be security software. This will be high concern
due to the “green movement” and everything becoming electronic. This software will need to be
advanced for personal and business security. The more that becomes electronic, the more that
private information is available to be stolen.
Lastly, cloud computing will have a huge impact on the software industry. As more and more
consumers are interested in the cloud platform, software companies will need to revamp their
software to run efficiently and effectively on the cloud platform. This will most likely lead to a
situation where software items such as Microsoft Word can be purchased and installed on a
computer or you can purchase a subscription to Word that will be implemented on the cloud.
One thing that is for sure is that it will be an exciting year for software as the industry shifts
67 | X S E I F S e m i -­‐ A n n u a l R e p o r t from their traditional purchase and install to software subscriptions, cloud computing, and
tablet or smart phone platforms.
Semiconductors
Semiconductors should see an increase in value due to the fact that there are more and more
components that need to be made for each new piece of hardware that is created. Designing the
technology that comes out will play a major role in the future. Also another reason to be
encouraged by semiconductors going forward is that when there is a cyclical correction,
spending on a tech service tends to decline less than hardware.
Hardware
The idea of convergence between a PC and a mobile phone has been the topic of discussion for
many years. With the invention of the iPhone and iPad people were able to see how this
convergence could start to play out. Although the mobile phone market and the tablet market
are heating up, the software and system capabilities of these hardware devices will determine
the success of the products. Their ability to involve cloud computing into these hardware’s will
also be an indicator of hardware’s success in the future.
The tablet market should see the most growth in the near future for the Technology sector.
Apple’s iPad sales were up 311% for 2011. Many new tablets have been introduced to the market
to try and take some the market share away from Apple. Other tablets have been released by
Amazon, Barnes and Noble, Samsung, Sony, among others. All of these companies see a
tremendous growth opportunity in the tablet market.
Unlike software, hardware requires larger capital investment and is thus seen as more risky. If
companies decide to invest in the hardware expansion there is a risk that it will not sell, or that
sales will not meet estimates. This could pose a substantial financial setback to a company who
invested the capital. Software is much easier to scale up or down in production to meet demand
and thus poses less risk in a risky sales environment.
Analyst Future Outlook
Since the economy is demanding lower prices, companies need to become more efficient.
Technology can provide a way to become more efficient after all costs are cut. Cloud Computing
will help cut back technology storage and will allow companies to access all records on any
qualified device. Interactions with smartphones have grown within the last five years, first time
this summer there were more smartphone purchased than any other type of phones. Due to the
green movement and a lower operating cost, companies are taking the paperless route, which
could expand the software companies into a variety of applications, including advertising, and
media. Robotics is increasing in the military allowing for fewer casualties. Advertising on
internet web browser are increasing which provides a great deal of revenue.
68 | X S E I F S e m i -­‐ A n n u a l R e p o r t MATERIALS By Daniel Strong
Sector Allocation Recommendation:
Underweight
Current Sector Weight in Portfolio
3.29%
Current Sector Weight in Benchmark
3.44%
Benchmark Weight ± 50%
1.72-5.16%
Sector Stocks in Portfolio
3
Sector Stocks in Benchmark
30
Portfolio Sector Weighted Beta
1.27
Benchmark Sector Weighted Beta
1.21
Sector Summary
The materials sector is very sensitive to changes in the market as a whole because of its high
sensitivity to business cycles. The materials sector is a volatile area that closely follows the
trends of the market and the S & P 500. While it is closely correlated to the swings of the market
the materials sector tends to move in the same direction as the market but with higher gains and
larger losses than the market.
It is for this reason that I recommend underweighting the materials sector in the near future. I
believe the market will fall because of concerns over Greece defaulting. If this does happen the
materials market will follow suit but with larger losses than the S & P 500 will see.
The companies in the materials sector are highly dependent on other industries and the
performance of the market as they are involved in the discovery, development, and processing of
raw materials. Thus the companies that make up this industry are very dependent on the
demand of their products which in turn are dependent on demand for them. The demand for
materials is primarily driven by the business cycles of the automobile industry and the
construction industry. As I see the outlook for the market being unpromising I believe that
demand for the goods that the materials sector company’s produce will be down and as I
mentioned before this sector could see larger losses than other industries.
69 | X S E I F S e m i -­‐ A n n u a l R e p o r t Comparative Returns
Materials Index vs. S&P 500
Sector Holding Analysis
As of September 30, 2011 the fund owned three materials sector stocks (AA, PX, SIAL)
who account for 3.30% of the fund’s total value.
Market Cap Ticker (millions) $ PX US Equity 30,062.88 SIAL US $ Equity 7,610.50 $ AA US Equity 11,515.77 P/E EV/EBITD
A TTM Beta Estimate 3 yr EPS Growth 18.840 10.745 0.94 124.28% 17.149 10.185 1.08 117.13% 11.260 6.366 1.49 144.84% EBIT Margin TTM ROE 21.5
21.37208 2 20.9
25.62748 7 1.94
5.967734 4 Alcoa Inc. (NYSE: AA)
Close Price (9/30/11): $9.57
Total Shares Owned: 2300
Percent of Sector: 53.19%
Percent of Fund: 1.76%
70 | X S E I F S e m i -­‐ A n n u a l R e p o r t Alcoa is the world’s third largest producer of aluminum and operates in 31 countries. Alcoa is
the world’s largest producer of primary aluminum, fabricated aluminum, and alumina though it
is growing in all major aspects of the industry. Aluminum and alumina account for more than
three-fourths of Alcoa’s revenue. Alcoa operates in four business segments: Alumina, Primary
Metals, Flat-Rolled Products, and Engineered Products and Solutions. The company was
founded in 1919 and is headquartered in Pittsburgh, Pennsylvania.
Alcoa had a projected sales increase of 19% in 2011 and is forecasted to gain 2.6% in 2012.
Alumina and aluminum prices and volume are expected to increase in 2012 based on an
expected increase in demand. Earnings per share of Alcoa are expected to rise in 2012 to $0.96
from $0.81 projected in 2011. Alcoa is expected to see increased operating profits based off of
higher demand and the production of new lower cost plants. Alcoa is currently trading near its
52 week low of $8.45 and much lower than its high of $18.47.
I believe we should hold on to our shares of Alcoa based upon the projection that prices for
alumina and aluminum will increase along with volume in 2012. Alcoa has a relatively high beta
of 2.09 but I believe it is still worth the risk to hold on to Alcoa as I project them to be able to
reach I higher stock price in the near future.
Praxair Inc. (NYSE: PX)
Close Price (9/30/11): $93.48
Total Shares Owned: 75
Percent of Sector: 16.94%
Percent of Fund: 0.56%
Praxair is one of the world’s largest industrial gases companies in the world and the largest in
North and South America. They supply atmospheric, process and specialty gases, highperformance coatings, and related services for their customers in over 30 countries. Praxair
serves a variety of industries including: metals, health care, food and beverage, energy,
electronics, and chemicals. The company was founded in 1907 and is headquartered in
Danbury, Connecticut.
Like most companies in the materials sector Praxair is highly dependent on global demand for
its products which is dependent on other industries which are driven by the global economy’s
movement. Unlike Alcoa, Praxair is in the more specialized field of gases, with the problems
going on in Greece I do not see Praxair fairing as well as other companies that deal in more
generic goods. Praxair also sold its U.S. home health care business in March 2011 which saw
annual sales of about $150 million. Praxair is also highly dependent on energy costs as they are
their highest costs, is energy costs rise PX may see their profit margins shrink.
71 | X S E I F S e m i -­‐ A n n u a l R e p o r t Praxair accounts for only 0.55% of our fund’s holdings which will make any gains or losses in the
future insignificant. I recommend we sell our stake in PX and use the funds for a company with
better growth potential.
Sigma-Aldrich Corp. (NYSE: SIAL)
Close Price (9/30/11): $61.79
Total Shares Owned: 200
Percent of Sector: 29.86%
Percent of Fund: 0.99%
Sigma-Aldrich Corporation does business in a range of chemicals, biochemicals, and equipment
worldwide. SIAL sells over 100,000 chemicals with over 80,000 customers, including scientific
research institutions and pharmaceutical companies. SIAL can be seen as more of a life sciences
and technology company than a chemical company as its products are used primarily in
scientific research and pharmaceutical development. SIAL was created by the merger of Sigma
Chemical and Aldrich Chemical companies in 1975 and is headquartered in St. Louis Missouri.
There are a number of risks that I see in Sigma-Aldrich and in an uncertain economy I believe
SIAL is too risky for us to hold. SIAL’s products are generic and available from many competing
companies but they separate themselves by offering same-day shipping. A result of this is SIAL
has above-average inventories which during a bad economy can cause problems with low cash
availability and thus adding risk due to low liquidity. SIAL’s largest source of income is from
international sales which makes their profits highly dependent on foreign currency trends and
the United States dollar’s value.
SIAL accounts for less than 1% of our fund’s holdings and with their sales and profits being very
difficult to predict I believe we should sell our stake in them and find a less risky company to
invest in.
Changes in Sector Holdings
-­‐
Sold 75 shares of PX on 5/5/11
-­‐
Sold 100 shares of SIAL on 5/5/11
72 | X S E I F S e m i -­‐ A n n u a l R e p o r t Sector Breakdown
The Materials sector is a collection of companies that are involved in the discovery,
development, and processing of raw materials. This also includes the mining and refining of
metals, chemical producers, and forestry products. This sector is highly sensitive to changes in
the business cycle as they supply materials for construction and other industries which rely on a
strong economy. Supply and demand fluctuations also greatly affect the materials sector
because prices of raw materials are largely driven by demand.
Prospects
DOW CHEMICAL (DOW)
Dow is a provider of plastics, chemicals, and agricultural products that does business in over 175
countries and is the third largest chemical company by market capitalization. Dow’s annual
R&D is over $1 billion, and as a result they are consistently coming up with new and improved
areas of revenues that can add value to the company. Dow was founded in 1897 and is
headquartered in Midland, Michigan.
POTASH CORP. OF SASKATCHEWAN, INC. (POT)
PotashCorp is the world’s largest potash producer and the third largest producer of nitrogen and
phosphate, these being the three primary crop nutrients used to produce fertilizer. PotashCorp
was founded in 1975 and is headquartered in Saskatoon, Saskatchewan, Canada.
Analysts Future Outlook
The materials sector has kept in-line in terms of performance with the S&P 500 index, following
it in its up and downs but historically it can show larger losses and greater gains than the index.
With uncertainty with Greek’s possible default I believe we should equally weight or
underweight the materials sector for our fund.
73 | X S E I F S e m i -­‐ A n n u a l R e p o r t TELECOMMUNICATIONS By Ben Homan
Sector Allocation Recommendation:
Neutral
Current Sector Weight in Portfolio
3.42%
Current Sector Weight in Benchmark
3%
Benchmark Weight ± 50%
1.5-4.5%
Sector Stocks in Portfolio
2
Sector Stocks in Benchmark
8
Portfolio Sector Weighted Average Beta
.66
Benchmark Sector Weighted Average Beta
.69
Sector Summary
Since March 31st, both the Telecom sector and the S&P 500 have suffered negative returns.
However, Telecom has experienced less price volatility and outperformed the S&P, especially
over the final two months of the period. As seen in the graphs below, the Telecom sector has
outperformed the market during the past six months by almost 8%. Additionally, both DCF
Telecom holdings American Tower and AT&T outperformed the Telecom index as a whole.
Comparative Returns
S&P 500 v. S&P 500 Telecom Index
74 | X S E I F S e m i -­‐ A n n u a l R e p o r t Performance – DCF Holdings vs. Telecom sector
Strengths and Weaknesses
Strengths
The Telecom industry is a global system that affects almost everyone in the world. It connects
the world and makes communication almost effortless. Because the need for industry is strong
and will continue to be so in the future, there is no worry that the sector will become irrelevant.
A significant strength for Telecom companies comes in the fact that due to the high
requirements of startup capital, the threat of viable new entrants to the market is relatively low.
This has been especially true in the past several years. The depressed U.S. market and new
regulations have made financing more difficult to come by for potential Telecom startups. As it
stands, 78% of Telecom revenue in the U.S. comes from just four companies: AT&T, Verizon,
Sprint, and T-Mobile.
An additional strength for the sector comes in the development of data plans and similar
services. Wireless providers now provide data plans which allow users to connect to the internet
via their phones. These data plans come with different usage limits and varying costs and are
increasingly becoming necessary. It is estimated that only 60% of wireless customers have data
plans. As this percentage increases, Telecom sectors will be able to enjoy continued revenue
growth.
75 | X S E I F S e m i -­‐ A n n u a l R e p o r t Weaknesses
As discussed above, the sector requires large amounts of capital. The industry is one of the most
dynamic, and Telecom companies must continually invest in new technology. This in
combination with the necessary leasing of communication tower space results in relatively low
margins. Despite the threat of new entrants being relatively low, the Telecom sector experiences
a high degree of competition. Because products and services do not significantly differ from
carrier to carrier, customers look for the lowest prices while still receiving reliable service. This
means that the power of the buyers is very high and Telecom companies must compete on a low
cost strategy. High capital requirements, low margins, and necessary low product cost results in
a sector that is difficult to compete in unless you are one of the large and well established
companies.
Sector Holdings Analysis
During the period, the D’Artagnan Capital Fund held two stocks in the Telecom sector. These
were American Tower and AT&T. Compared to our S&P 500 benchmark, the fund was
overweight. Below is a brief description of the holding.
DCF TELECOM HOLDINGS as of NOVEMBER 6, 2011
Company Name
Market Capitalization Total Revenue (LTM) EBITDA (LTM)
AT&T (T)
$174.5B
$124.3B
$39.01B
American Tower (AMT) $22.64B
$2.34B
$1.41B
EBITDA Margin ROE
EV/EBITDA Dividend Yield Beta
31.38% 10.33%
5.84
5.90% 0.47
60.26%
7.91%
20.25 -­‐
0.39
AT&T, Inc. (NYSE: T)
Closing Price (9/30/11): $28.52
Shares: 600
Percentage of Portfolio: 1.36%
Percentage of Sector: 38.88%
View: AT&T is the largest provider of mobile telephony and fixed telephony in the United
States, and is also a provider of broadband and subscription television services. As of 2010,
AT&T is the 7th largest company in the United States by total revenue, as well as the 4th largest
non-oil company in the US. Domestically, they serve 95.5 million wireless subscribers and
operate in all 50 states as well as Puerto Rico and the U.S. Virgin Islands.
Due to the high barriers to entry within the industry, AT&T enjoys relatively low competition,
coming primarily from two companies, Verizon and Sprint. Despite relatively high market
saturation, AT&T has opportunities to continue revenue growth through several areas. Only
76 | X S E I F S e m i -­‐ A n n u a l R e p o r t around 60% of AT&T customers have data plans currently, and demand for data usage is
predicted to increase 8-10x by 2015. As this demand and usage increases, AT&T can expect to
grow revenues. To meet increasing demand, AT&T has proposed a merger with T-Mobile, the 4th
largest of the wireless providers. This move has been blocked by the Department of Justice and
is presently being reviewed. If this passes, AT&T will substantially increase its network and
subscriber base.
Currently, AT&T is the sole holding of the DCF in the telecom sector. We believe that holding
just AT&T, based on the growth opportunities presented, provides a greater opportunity to
outperform the market than by holding several telecom stocks. In addition to potential price
appreciation, AT&T has one of the most attractive yields in the S&P at 5.90%.
American Tower, Inc. (NYSE: AMT)
Closing Price (9/30/11): $53.80
Shares: 500
Percentage of Portfolio: 2.14%
Percentage of Sector: 61.12%
View: American Tower develops, owns, and operates communications sites; and leases antenna
space on multi-tenant communications sites to wireless service providers, and radio and
television broadcast companies. American Tower owns approximately 21,000 towers in the
United States as well as an additional 18,000 internationally in Brazil, Chile, Colombia, Ghana,
India, Mexico, Peru, South Africa and the United Kingdom.
Because of the high costs associated with building and/or acquiring towers, American Tower has
very little competition. However, American Tower’s revenue growth faces risk from potential
mergers among wireless carriers. Their revenues are generated by four main companies both
domestically and abroad, so changes involving these companies could significantly impact
American Tower’s financial position.
Changes in Sector Holdings
5/3/11 -- Verizon (VZ) – Sold 300 shares at $38.00
Screening Process
Telecom stocks were selected based on the following requirements:
1) Leading market share within the industry
2) Consistent positive earnings over the last 3 years
77 | X S E I F S e m i -­‐ A n n u a l R e p o r t 3) Low valuation multiples compared to industry averages
4) Undervalued discounted cash flow model
Because the Telecom sector is so small, the screening requirements differ slightly from other
sectors. Because of the capital requirements, a large market capitalization relative to the sector
is important. A company must then have produced positive earnings for the last several years.
If a Telecom company is consistently failing to produce profits, the capital requirements will be
difficult to meet and could result in the company falling behind competitors in terms of
innovation and quality of service. After additional qualitative analysis, a relative valuation and
discounted cash flow model are performed to evaluate whether or not the company is
undervalued.
Prospects
AT&T (T)
AT& T has proposed a merger with T-Mobile. Currently being blocked by the Department of
Justice, if the merger goes through, AT& T will significantly increase its network coverage and
quality as well as provide additional revenue through an increased customer base. AT& T also
provides one of the most attractive dividend yields in the S&P 500 at 5.90%. The income from
the high yield, in addition to the potential revenue gains from the T-Mobile merger make AT& T
an intriguing prospect.
MetroPCS (PCS)
MetroPCS communications are a small, fairly new entrant into the Telecom industry. Although
it has not established profitability yet, MetroPCS should be monitored due to its differentiation
strategy. While most Telecom carriers provide 4G plans solely on a 1 to 2 year basis with
smartphones costing over $200, MetroPCS is attempting to corner a different part of the
market. Management made the correct decision in skipping the construction of a 3G network
and moving directly to 4G. MetroPCS is targeting consumers that want 4G capabilities while on
a month to month plan. Additionally, they are working with suppliers to develop 4G capable
phones in the $100-150 range.
Sector Breakdown
The industry has two main segments: wireless and wireline services.
Wireline
Originally the main revenue driver of the industry, wireline services deal primarily with home
phone services. Growth in this segment has been stagnant as people continue to rely more on
wireless plans. Wireline providers have tried to offset this by increasing their services in
wireline video and business aspects.
78 | X S E I F S e m i -­‐ A n n u a l R e p o r t Wireless
Wireless has been the primary growth driver of the industry. Cell phone usage has exploded
over the last decade and revenues continue to grow as more people are upgrading to
smartphones and the required data packages. However, the percentage of revenues generated by
wireless voice services has decreased since 2009, with data plan revenue increasing to now 33%
of total Telecom revenues.
Analyst Future Outlook
Our recommendation is to move towards neutrally weighting the Telecom sector. Due to the
high domestic market saturation, future valuation models should begin to reflect slightly
slowing growth rates. However, we believe that margins should improve slightly as companies
begin to focus more on cost control.
79 | X S E I F S e m i -­‐ A n n u a l R e p o r t UTILITIES By Nicholas Laborie
Sector Allocation Recommendation:
Current Sector Weight in Portfolio:
Underweight
3.14%
Benchmark Weight ± 50%:
1.88% - 5.63%
Sector Stocks in Portfolio:
3
Sector Stocks in Benchmark:
Portfolio Sector Beta:
Benchmark Sector Beta:
35
0.76
0.78
Sector Summary
With only modest improvement expected in the housing and power markets, look for utility
stocks to realize only a modest advance in 2012. Along with the slowly recovering housing and
power markets, political turmoil has greatly affected growth opportunities in utilities
companies; with the government implementing new policies and regulations on nuclear energy,
costs have risen and projects have halted. However, with the constant volatility shown by the
market in recent months, the DCF should perhaps consider moving to a neutral weighting in the
sector. Although, the priority should be allocating money into better opportunities and these
opportunities are few and far between in the utilities sector.
The D’Artagnan Capital Fund currently holds 3 stocks in the Utilities industry: PG&E
Corporation (PCG), Progress Energy (PGN), and NRG Energy (NRG). In comparison to the S&P
500, DCF is currently underweight in the sector.
Currently two of our three stock holdings fall into the upper-tier of the S&P 500 Utilities sector
market capitalization size and also have lower betas than the overall sector. This shows that DCF
currently holds positions in less risky securities in an already relatively defensive industry
during a very volatile time period.
In the following report, there will be a discussion of screening process for security selection
using relative analysis, the advantages and disadvantages of investing in the utilities sector, and
the reasoning behind the recommendation of an underweight allocation in this sector.
80 | X S E I F S e m i -­‐ A n n u a l R e p o r t Comparative Returns
Utilities Index vs. S&P 500
Current Holdings Analysis
Progress Energy (NYSE: PGN)
Shares owned: 300
Close Price (4/15/2011): 46.43
Progress Energy, headquartered in Raleigh, N.C., is a Fortune 500 energy company with more
than 22,000 megawatts of generation capacity and approximately $10 billion in annual
revenues. Progress Energy includes two major electric utilities that serve about 3.1 million
customers in the Carolinas and Florida.
The company is pursuing a balanced strategy for a secure energy future, which includes
aggressive energy-efficiency programs, investments in renewable energy technologies and a
state-of-the-art electricity system. Although growth within the utilities sectors is very limited,
Progress Energy has taken the necessary steps to expand in emerging markets. Because of
forward-looking management and growth strategy, Progress Energy has proven to be an
undervalued security that demonstrates vast growth potential.
81 | X S E I F S e m i -­‐ A n n u a l R e p o r t PG&E Corporation (NYSE: PCG)
Shares owned: 425
Close Price (4/15/2011): 42.30
PG&E Corporation is a holding company that holds interests in energy based businesses. The
company’s holdings include a public utility operating in northern and central California that
provides electricity and natural gas distribution; electricity generation, procurement, and
transmission; and natural gas procurement, transportation, and storage.
PG&E Corporation has recently announced that it received approval of its revenue needs in the
2011-2015 Gas Transmission and Storage Rate Case from the California Public Utilities
Commission. This is an extremely important step for PG&E as it preserves the long-term safety
and reliability of natural gas service for customers at reasonable rates. With interest in nuclear
energy, PG&E Corporation is a company that has long-term stability potential and has proven to
be undervalued as well.
NRG Energy (NYSE: NRG)
Shares owned: 280
Close Price (4/15/2011): 21.52
NRG Energy, Inc., together with its subsidiaries, operates as a wholesale power generation
company. The company engages in the ownership, development, construction, and operation of
power generation facilities. It also involves in the transacting in and trading of fuel and
transportation services; the trading of energy, capacity, and related products in the United
States and internationally; and the supply of electricity, energy services, and cleaner energy and
carbon offset products to retail electricity customers in deregulated markets. The company
operates natural gas- fired, coal- fired, oil-fired, nuclear, solar, and wind power plants. As of
December 31, 2010, it had power generation portfolio of 193 operating fossil fuel and nuclear
generation units with an aggregate generation capacity of approximately 24,570 megawatt
(MW), as well as ownership interests in renewable facilities with an aggregate generation
capacity of 470 MW. The company portfolio also includes approximately 24,035 MW generation
capacity in the United States, and 1,005 MW generation capacity in Australia and Germany. In
addition, it has a district energy business with steam and chilled water capacity of approximately
1,140 megawatts thermal equivalent. NRG Energy, Inc. was founded in 1989 and is
headquartered in Princeton, New Jersey.
82 | X S E I F S e m i -­‐ A n n u a l R e p o r t Changes to Holdings
•
•
•
•
•
•
•
Purchased 300 shares of Progress Energy @ $39.66 (4/07/2010)
Sold 875 shares of Georgia Power Co. @ $25.46 (10/06/2010)
Sold 800 shares of Duke Energy Corp. @ $17.65 (10/13/2010)
Purchased 175 shares of PG&E Corp. @ $47.72 (12/17/2010)
Sold 350 shares of Dominion Resources @ $42.11 (12/17/2010)
Sold 200 shares of PG&E @ $45.52 (5/10/2011)
Purchases 280 shares of NRG Energy @ $24.10 (5/10/2011)
Relative Analysis
The following list represents the 35 companies in the Utilities Sector of the S&P 500 sorted by
market capitalization in descending order; current holdings are shaded.
Ticker SO US Equity D US Equity EXC US Equity DUK US Equity NEE US Equity AEP US Equity SE US Equity FE US Equity ED US Equity PPL US Equity PEG US Equity PCG US Equity PGN US Equity EIX US Equity SRE US Equity XEL US Equity ETR US Equity AES US Equity DTE US Equity CNP US Equity OKE US Equity CEG US Equity AEE US Equity WEC US Equity NI US Equity NU US
SCG
EquityUS
Equity CMS US Equity NRG US Equity PNW US Equity XYL US Equity POM US Equity TEG US Equity TE US Equity GAS US Equity Company Name Market Cap P/E Total Return YTD Beta - 1 yr EBITDA Margin Dividend Yield SOUTHERN CO $ 37,050,601,472.00
18.46 18.41 0.55 33.44 4.37 DOMINION RES/VA $ 29,369,139,200.00
16.63
24.52
0.68
30.25
3.82 EXELON CORP $ 29,185,810,432.00
10.24 9.76 0.69 35.61 4.77 DUKE ENERGY CORP $ 27,488,329,728.00
14.43
20.71
0.64
39.23
4.84 NEXTERA ENERGY $ 23,847,940,096.00
12.92 11.82 0.75 31.97 3.90 AMERICAN ELECTRI $ 19,171,620,864.00
15.75 14.71 0.72 31.85 4.74 SPECTRA ENERG $ 19,072,710,656.00
16.57
20.99
0.96
47.83
3.82 FIRSTENERGY CORP $ 19,033,030,656.00
13.46 29.48 0.76 25.48 4.83 CONS EDISON INC $ 17,152,499,712.00
16.54
22.24
0.62
24.01
4.10 PPL CORPORATION $ 17,141,820,416.00
10.27 17.18 0.65 37.26 4.72 PUB SERV ENTERP $ 17,140,060,160.00
11.64
9.93
0.80
33.60
4.04 PG&E CORP $ 16,584,380,416.00
12.09 -11.82 0.64 28.90 4.45 PROGRESS ENERGY $ 15,513,749,504.00
17.50 27.64 0.65 30.00 4.71 EDISON INTL $ 13,280,060,416.00
13.41
8.33
0.76
29.16
3.14 SEMPRA ENERGY $ 12,859,199,488.00
12.01 4.98 0.82 26.98 3.58 XCEL ENERGY INC $ 12,637,949,952.00
15.06
14.21
0.71
26.25
3.99 ENTERGY CORP $ 12,279,230,464.00
8.76 1.74 0.73 33.55 4.78 AES CORP $ 9,141,498,880.00
10.54
-2.22
1.17
27.96
0.00 DTE ENERGY CO $ 8,821,357,568.00
14.16 19.14 0.78 27.21 4.51 CENTERPOINT ENER $ 8,650,692,608.00
14.40 33.57 0.85 26.26 3.89 ONEOK INC $ 7,984,748,032.00
25.76
44.20
0.95
9.38
2.89 CONSTELLAT ENER $ 7,893,816,832.00
17.27 30.66 0.79 9.48 2.45 AMEREN CORP $ 7,803,406,848.00
11.25
19.28
0.84
29.59
4.96 WISCONSIN ENERGY $ 7,567,079,936.00
14.81 14.13 0.75 26.71 3.18 NISOURCE INC $ 6,249,098,240.00
16.47
32.03
0.83
23.95
4.14 NORTHEAST UTILS $ 6,131,131,904.00
14.20 11.35 0.80 29.39 3.17 SCANA CORP $ 5,498,824,192.00
14.30 8.87 0.76 26.47 4.55 CMS ENERGY CORP $ 5,220,815,872.00
13.64
15.53
0.80
23.32
4.08 NRG ENERGY $ 5,191,739,904.00
32.61 10.13 1.01 22.45 0.00 PINNACLE WEST $ 5,049,631,744.00
15.73
17.11
0.79
37.35
4.54 XYLEM INC $ 4,660,149,760.00
1.61 PEPCO HOLDINGS $ 4,443,806,208.00
15.18
11.93
0.82
17.44
5.52 INTEGRYS ENERGY $ 4,144,561,920.00
16.49 13.64 0.86 15.06 5.14 TECO ENERGY INC $ 4,101,729,024.00
15.33 10.62 0.89 27.98 4.53 NICOR INC $ 2,531,855,104.00
23.26
14.27
0.75
15.05
3.34 83 | X S E I F S e m i -­‐ A n n u a l R e p o r t Screening Process
The utilities sector in general is more of a value-oriented sector rather than a growth one. Most
electric utilities have a franchise territory. Electric utilities that are in well-developed states may
not have a lot of opportunity to grow their business. They are limited by the geographic size of
their franchise territory. By analyzing P/E, EV/EBITDA, and dividend yields this allows for
accurate valuation of any securities within the utilities sector. However, also utilizing qualitative
analysis to search for those rare utilities companies striving to expand into new markets and
projects (as will be seen by potential prospects) has proven to be important as well. Steps in
application of screening process:
1. List stocks currently listed in S&P 500 Utilities Index
2. Target companies with P/E ratio lower or equal to average P/E ratio (because growth is
limited, do not eliminate companies that fall near the average until performance of
qualitative analysis to further analyze their growth potential).
3. If company issues dividends, analyze projected 3 year dividend growth and see if it is
aligned with the average or if they plan to stop paying dividends (this is an important
factor because dividends can be an attractive surplus when investing in utilities).
4. Take into consideration EBITDA margins and eliminate any companies that fall well
below the average, as this shows poor efficiency.
NOTE: Screening process is merely a functional execution of how to find undervalued
stocks in my sector; however, if research provides an opportunity within that company,
further valuation will be implanted to make a decision.
Prospects
Based on the screening process as well as the qualitative research, two potential securities could
be undervalued as well as one stock that showed promising growth (NRG).
Ticker
EXC US Equity
ETR US Equity
AES US Equity
Company Name
EXELON CORP
ENTERGY CORP
AES CORP
Market Cap
$ 29,185,810,432.00
$ 12,279,230,464.00
$ 9,141,498,880.00
P/E Total Return YTD Beta - 1 yr EBITDA Margin Dividend Yield
10.24
9.76
0.69
35.61
4.77
8.76
1.74
0.73
33.55
4.78
10.54
-2.22
1.17
27.96
0.00
Exelon Corporation (NYSE: EXC)
Exelon Corporation is a utility services holding company. The company, through its subsidiaries
distributes electricity to customers in Illinois and Pennsylvania. Exelon also distributes gas to
customers in the Philadelphia area as well as operates nuclear power plants in states that
include Pennsylvania and New Jersey. Because nuclear power constitutes 20% of U.S.
electricity, does not produce greenhouse emissions, and is at least for existing plants a low-cost
source of energy: Exelon proves to be undervalued not only because it has many operations in
84 | X S E I F S e m i -­‐ A n n u a l R e p o r t nuclear energy, but also its 8% decline in the past month due to market overreaction in respect
to the natural disasters in Japan and the nuclear meltdown.
Entergy Corporation (NYSE: ETR)
Entergy Corporation, together with its subsidiaries, engages in electric power production and
retail electric distribution operations in the United States. The company operates in two
segments, Utility and Entergy Wholesale Commodities. The Utility segment involves in the
generation, transmission, distribution, and sale of electric power in the portions of Arkansas,
Mississippi, Texas, and Louisiana, including the City of New Orleans. This segment operates
coal, gas, and hydro power generation facilities, as well as a natural gas distribution business.
The Entergy Wholesale Commodities segment owns and operates six nuclear power plants in the
northern United States that sell the electric power produced by those plants to wholesale
customers. This segment also provides services to other nuclear power plant owners; and owns
interests in non-nuclear power plants that sell the electric power produced by those plants to
wholesale customers.
AES Corporation (NYSE: AES)
The AES Corporation, through its subsidiaries, operates as a power company in Latin America,
Africa, North America, Europe, the Middle East, and Asia. The company owns and operates two
businesses, Generation and Utilities. The Generation business owns and/or operates power
plants to generate and sell power to wholesale customers, such as utilities and other
intermediaries. It generates electricity through various sources, including coal, gas, fuel oil,
biomass, hydroelectric, wind, and solar. The Utilities business owns and/or operates utilities to
distribute, transmit, and sell electricity to end-user customers in the residential, commercial,
industrial, and governmental sectors. As of December 31, 2010, the company owned electricity
generation and distribution facilities with a total capacity of approximately 40,500 megawatts
and distribution networks serving approximately 12 million people in 28 countries.
Strengths and Weaknesses
Strengths
1.) High dividend yields
2.) With the Federal Reserve keeping interest rates low and interest rates on C.D.’s and
savings accounts being miniscule, investors are turning to electric utilities as an
attractive replacement.
3.) Development of more nuclear projects is bringing more growth to the utilities sector as a
whole.
85 | X S E I F S e m i -­‐ A n n u a l R e p o r t Weaknesses
1.) Environmental considerations dealing with emissions of pollutants.
2.) Very difficult for utilities companies to build coal-fired generating facilities due to
strict opposition from environmentalists and the public.
3.) Sharp increases in the costs of building materials and labor have made any kind of
utility construction much more expensive.
4.) Electric utilities will be facing significant new challenges adjusting to the green
initiatives put in place by the new administration and Congress. Coal generates 56%
of electricity in the United States which is a significant contributor to carbon
emissions.
5.) The cost to reduce carbon emissions will have a significant impact on the economics
of the utilities sector and their support industries.
6.) With the recent natural disasters faced in Japan, many nuclear projects have been
halted and current nuclear power plants are being reevaluated for safety.
7.) New government regulations on nuclear energy will raise costs for utilities
companies.
8.) Due to price regulation and prices increasing, utilities companies will have more
trouble passing on costs to customers and eventually have to incur some of the costs.
9.) Weather and natural disasters
Analyst Future Outlook
Although utilities are less volatile, less risky, and offer high dividend yields to investors, the
opportunities for capital appreciation and high returns are lacking. With new government
implementations and regulations dealing with emissions of pollutants and nuclear power plant
safety issues, there will be a long-term struggle for utilities companies in general. As prices
continue to rise, more and more companies have cut down on their dividend growth, which
happens to be the most attractive reason to invest in utilities. Companies will also be faced with
issues passing on rising prices to consumers as the government may intervene and disallow
companies to do so. With the U.S. economy recovering and Europe starting to show signs of life,
investors will lean more towards cyclical sectors rather than defensive ones. For these specific
reasons, underweighting the utilities sector and focusing on allocating money towards better
opportunities would be the strategically correct thing to do. This being said, because the fund
takes a bottom-up approach to investing, the fund will always be looking for opportunities in the
utilities sector that have good growth potential and high returns. In this report there are 3
potential securities that will be looked at throughout the semester and the fund may potentially
reduce its position in a current security to take advantage of these opportunities.
86 | X S E I F S e m i -­‐ A n n u a l R e p o r t CURRENT HOLDINGS AS OF SEPTEMBER 30, 2011 Abbott Labs (ABT)
500 Shares
Exxon Mobil Corp. (XOM)
300 Shares
Aflac Inc. (AFL)
250 Shares
FedEx Corp. (FDX)
450 Shares
Alcoa Inc. (AA)
2300 Shares
General Electric Co (GE)
1450 Shares
American Towers (AMT)
500 Shares
General Motors Co (GM)
1700 Shares
Apple Inc. (AAPL)
200 Shares
Google Inc. (GOOG)
60 Shares
AT&T Inc. (T)
600 Shares
Illinois Tool Works Inc. (ITW)
1030 Shares
BP PLC (BP)
1140 Shares
Intel Corp. (INTC)
1500 Shares
Chevron Corp (CVX)
440 Shares
Johnson & Jonson (JNJ)
400 Shares
Chesapeake Energy Corp (CHK)
750 Shares
JPMorgan & Chase Co (JPM)
780 Shares
Chubb Corp. (CB)
500 Shares
Kellogg Co. (K)
400 Shares
Cognizant Tech Solutions (CTSH)
850 Shares
Key Corp (KEY)
4200 Shares
CSX Corp (CSX)
1950 Shares
McDonald’s Corp (MCD)
700 Shares
Express Scripts Inc. (ESRX)
400 Shares
Microsoft Corp. (MSFT)
2100 Shares
87 | X S E I F S e m i -­‐ A n n u a l R e p o r t NRG Energy Inc
300 Shares
RR Donnelley & Sons Co
535 Shares
Peabody Energy Corp. (BTU)
250 Shares
Sigma Aldrich Corp. (SIAL)
200 Shares
Pepsico Inc. (PEP)
600 Shares
Teva Pharmaceutical Industries
(TEVA)
575 Shares
PG&E Corp. (PCG)
425 Shares
PNC Financial Services Group (PNC)
1100 Shares
Praxair Inc. (PX)
75 Shares
Procter & Gamble Co. (PG)
500 Shares
Total SA (TOT)
600 Shares
US Bancorp (USB)
300 Shares
UnitedHealth Group Inc (UNH)
750 Shares
Visa Inc. (V)
935 Shares
Progress Energy Inc (PGN)
300 Shares
Qualcomm Inc. (QCOM)
600 Shares
Wal-Mart Stores Inc. (WMT)
375 Shares
88 | X S E I F S e m i -­‐ A n n u a l R e p o r t 
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