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THE DOW JONES BUSINESS AND FINANCIAL WEEKLY
Q&A
www.barrons.com
JUNE 17, 2014
4 Mid-Cap Stocks Growing Faster Than the Market
Rob Lanphier of William Blair & Company has beaten the market in good times and bad. Here’s what he likes now.
By TERESA RIVAS
Small and mid-cap stocks have had
a monster half-decade, with the Russell
2500 Index logging a compound annual
growth rate above 24% in the five years
ended 2013. Rob Lanphier says that kind
of outperformance isn’t likely to be sustainable.
The observation might seem obvious,
except that Lanphier is co-manager of
the William Blair Small-Mid Cap Growth
Fund (ticker: WSMNX). Generally, fund
managers are not scrambling to lower expectations for their asset class, but after
their “unbelievable run,” Lanphier is lowering expectations.
The manager says the rising tide
“raised all boats indiscriminately” in recent years, but now is the time when
higher-quality names can distinguish
themselves, as interest rates creep up
and euphoria fades. His team looks to buy
companies with market value between
$500 million and $8 billion that they believe have strong management and can increase earnings faster than average over
a number of years.
That strategy has paid off, allowing
the fund, which gets a four-star rating
from Morningstar, to generate returns
of 9.9% in the past decade, beating the
9.7% for the Russell 2500 and peers in its
category. Not only did Lanphier and his
team beat the benchmark last year, when
small-caps were on a tear, they also outperformed in 2007, 2008 and 2009, during
the worst of the recession and the sector’s
rapid rebound.
Today, Lanphier sees opportunity from
health care to transportation, with companies that have a long runway of growth
ahead.
Read excerpts from his conversation
with Barrons.com below.
Barrons.com: Let’s talk about Stericycle
(SRCL), your largest holding. You added
to your position at the end of the first
quarter.
Lanphier: Not only is it our largest hold-
ing, but it is also our oldest holding in
the portfolio. We’ve been a holder of the
company ever since it went public [more
than a decade ago.]. Sometimes it has
been a bigger position, sometimes it has
been a smaller one. The investment thesis
on Stericycle is the notion that this company should be able to grow stronger for
longer: It should be able to sustain midteens earnings growth for an extended
period of time. I can’t think of another
company in the portfolio where I have
that level of conviction, and at the same
time if you looked at the valuation, which
is at about 25.5 times the next 12 months,
that’s below not only its five-year record
from a multiple standpoint, but it is also
below the relative multiple to the market.
Medical hazardous waste [collection
and disposal] is Stericycle’s core business,
whether it is in hospitals or dentist offices
or tattoo shops. The regulatory environment around medical hazardous waste has
become increasingly onerous over time,
and in this case that’s a positive: Stericycle is really sitting in the catbird’s seat.
It is by far the leader in this business,
domestically and internationally. About
70% of their revenues today are domestic, but over time you should expect that
they will gain increasing traction, particularly in Europe as the regulatory environment over there continues to become
more onerous as well. A couple of years
ago it created a division called StrongPak
Manager’s Bio
Name: Robert Lanphier
Age: 58
Title: Partner, William Blair & Co.; co-portfolio manager
Education: B.S. in management, Purdue
University; M.B.A., Northwestern University Kellogg Graduate School of Management
Hobbies: Reading, travel, hiking, snow
skiing, tennis and golf
for hazardous waste in general — things
like paint cans, aerosol cans that would
be used in a retail setting. So whether
you are CVS Caremark (CVS), Walgreen
(WAG), Home Depot (HD) or Target
(TGT), you are under tremendous scru(over p lease)
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Fund Facts
(as of June 3, 2014)
William Blair Small-Mid Cap
Growth Fund (WSMNX)
Assets:
$703.6 million
Expense Ratio:
1.1%
Front Load:
None
Annual Portfolio Turnover: 53%
Yield:
None
Source: Morningstar
Top 10 Holdings
(as of April 30, 2014)
Stericycle
j2 Global
Six Flags Entertainment
Old Dominion Freight Line
Affiliated Managers Group
Gartner
Robert Half International
Portfolio Recovery Associates
Sirona Dental Systems
HealthSouth
Source: Morningstar
SRCL
JCOM
SIX
ODFL
AMG
IT
RHI
PRAA
SIRO
HLS
tiny to handle hazardous waste in a very
defined way. So Stericycle is not resting
on its laurels, even as its core business
continues to do very well.
Your second-largest holding is Six Flags
Entertainment ( SIX ).
Six Flags is badly misunderstood. It is
an amusement park leader that frankly
has an enormous opportunity to monetize
many aspects of the amusement park by
new management that came in about four
years ago. The cost of an admission ticket
for an all-day experience is still relatively
low: This new management team sees this
substantial pricing power that they could
achieve and still grow admissions at the
same time – you get about a 4% increase
in pricing per year that is just the in-park
admission costs, which [leads to] margin
expansion. Six Flags has tremendous free
cash flow, and when you add back a dividend yield and some buybacks, you end
up with what could be a mid to high-teens
total return per year, and we really believe that could be sustained for the next
three to five years. The other thing to
keep in mind is that in a city you are not
going to have more than one amusement
park: They are pretty much a monopoly
to that area.
Old Dominion ( ODFL ) is a name I imagine
that has benefited from the resurgence of
transport.
If you look at the valuation, at 20 times
next 12 months, it is above its absolute
price/earnings ratio on a five-year basis.
But it is right in-line on a relative market-multiple basis. If you looked at the
top seven publicly traded less-than-truck
load (LTL) carriers, they together represent about 65% of the LTL market share,
with Old Dominion at 7% of that 65%. But
if you look at the revenue growth, Old
Dominion is growing dramatically faster
than any of the other players, and they
represent 35% to 40% of the total earnings before interest and taxes (EBIT) of
those seven companies. So this is a company that is not only growing faster than
the industry but is doing so more profitably than its peers.
I think that because of the margins
and the free cash flow that Old Dominion
has been able to generate, it is able to
reinvest in technology and in services at a
time when its competitors are struggling
to raise their margins to acceptable levels. Old Dominion is generating more and
more cash, which it is reinvesting and at
the same time giving back to shareholders in the form of dividends and share
buybacks. So not only does it have the
highest margins and the highest returns
in the industry, but from our standpoint as
long as it can continue to execute there is
no reason to think that’s going to change
any time soon. And their employees share
in the company’s success via constant and
consistent wage increases and above-average benefit packages, so Old Dominion
attracts and retains employees better
than anybody else in the industry.
A smaller position is Middleby ( MIDD ).
Lately we’ve been adding to it. Middleby
is a leading manufacturer of food service
equipment to the restaurant and food processing industry — it focuses on making
restaurant kitchens much more efficient,
in terms of energy savings, labor savings,
footprint of machines. As a result, there
is significant value-add, on average probably saving close to 30% of the total cost
to either a fast-food or casual-dining commercial kitchen environment; the payback
is usually less than two years. It has a
blue-chip list of clients, and we think it
can grow top line at midteens and bottom line at 20%-plus for the next three
years. So why now, other than the fact
that the multiple came down to 21 times
[after a disappointing first quarter]? It
acquired Viking, a well-known brand that
was poorly managed. Middleby has created a complete redesign and is launching more than 50 different Viking products this year with a commercial level
of sophistication that Viking never had
previously. At the same time it completed
the purchase of all of Viking’s distributors around North America, which adds
probably 1,000 basis points [10 percentage points] of margin by capturing that
distribution for themselves. Middleby had
a goal when it acquired Viking of getting the EBITDA [earnings before interest, taxes, depreciation and amortization]
margins from 8% up to 20%, and at the
end of 12 months they were at 19%.
Thanks.
The opinions and forecasts expressed in the article referenced are those of Rob Lanphier as of June 17, 2014, and may not actually come to
pass. This information is subject to change at any time based on market and other conditions and should not be construed as a
recommendation of any specific security. Not all securities held in the portfolio performed as favorably as those discussed, and there is no
guarantee that these securities will continue to perform favorably in the future. There is no guarantee that the Fund will continue to hold any
one particular security or stay invested in any one particular sector. Holdings are subject to change at any time. Investments are subject to
market risk.
Investing in smaller and medium capitalization companies involves special risks, including higher volatility and lower liquidity. Small and
mid-cap stocks are also more sensitive to purchase/sale transactions and changes in the issuer's financial condition.
After 7/31/2014, this material must be accompanied by a William Blair Fund Update, which includes performance data and top ten portfolio
holdings for the most recent calendar quarter.
The Small-Mid Cap Growth Fund’s Class N share 1-year, 5-year and 10-year performance returns as of May 31, 2014 are as follows:
Period Ending 5/31/2014
Small-Mid Cap Growth Fund
Russell 2500 Growth Index
1 YR
5 YR
10 YR
16.98%
18.51%
19.45%
20.97%
9.87%
9.64%
Expense Ratio for Class N shares
Gross: 1.46%
Capped: 1.35%
The Small-Mid Cap Growth Fund’s Class N share Morningstar Ratings as of May 31, 2014 are as follows:
Period Ending 5/31/2014
Overall 3 YR
5YR
10YR
Small-Mid Cap Growth Fund
Number of Funds in Mid Cap Growth Category
4
631
4
564
4
412
4
631
The Fund’s Adviser has contractually agreed to cap the Fund’s Expense Ratio until 4/30/15.
Performance cited represents past performance. Past performance does not guarantee future results and current performance
may be lower or higher than the data quoted. Returns shown assume reinvestment of dividends and capital gains. Investment
returns and principal will fluctuate with market and economic conditions and you may have a gain or loss when you sell shares.
For the most current month-end performance information, please call +1 800 742 7272, or visit our Web site at
www.williamblairfunds.com.
Morningstar Ratings™ are as of 5/31/14 and are subject to change every month. The ratings are based on a risk-adjusted return measure
that accounts for variation in a fund’s monthly performance, placing more emphasis on downward variations and rewarding consistent
performance. The top 10% of funds in each Category receive 5 stars, the next 22.5% receive 4 stars, the middle 35% receive 3 stars, the next
22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a fund is derived from a weighted average of
the performance figures associated with its three-, five-, and ten-year (if applicable) Morningstar Rating metrics. The Morningstar Mid Cap
Growth Category represents the average annual composite performance of all mutual funds listed in the Mid Cap Growth Category by
Morningstar.
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Please carefully consider the Fund’s investment objective, risks, charges, and expenses before investing. This and other
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William Blair & Company, L.L.C., Distributor.