A company’s balance sheet can predict its future, argues Bryant VanCronkhite, lead manager of the $5 billion Wells Fargo Special Mid Cap Value fund. A significant amount of cash on a balance sheet, for example, can unlock a company’s dormant potential, whether it’s through a smart acquisition or reinvestment.
VanCronkhite, 36, aims to get an edge by buying companies with strong balance sheets, but only when Wall Street is mispricing their stock. “Of course, the market won’t give credit until after it sees something happening,” he explains.
Of the 60-odd holdings in his fund (ticker: WFPCX), VanCronkhite highlighted private-label food maker TreeHouse Foods (THS), communications outfit Harris (HRS), fast-food chain Wendy’s (WEN), transaction processor DST Systems (DST), and set-top box maker Arris International (ARRS).
The fund manager starts out with an investible universe of 250 companies that meet four criteria: durable competitive advantages; strong, sustainable free cash flow; balance-sheet flexibility; and appropriately compensated management teams. Then he digs deeper, looking beyond typical measures such as debt to capital and debt to equity to determine balance-sheet strength, asking questions like “What’s the maturity profile?” and “What was the debt used for?” “We think of ourselves as bond investors in the equity world,” says VanCronkhite.
High standards for quality help cushion the fund during downturns. When the fund’s mid-cap value peer group was in the red by 37% in 2008, the fund was down 30%. Losing less over short stretches can lead to long-term gains. Over the past five years, the fund has returned 14% annually—net of its 1.99% in fees—beating the Standard & Poor’s 500 index’s 13% and 97% of the fund’s peers.
Barrons.com recently spoke with VanCronkhite and asked him to make the case for his top five cash-gushers.
TreeHouse Foods. VanCronkhite highlighted the Oak Brook, Ill.-based private-label food-products seller last year in a Barrons.com interview. Shares rose 28% to a high of $104 in July before settling to a recent $88. Last year, TreeHouse bought ConAgra ’s private-label business Ralcorp for $2.7 billion, a steep discount to the $5 billion ConAgra paid to acquire it in 2012. The acquisition was positive for TreeHouse, but investors expected too much, too soon. “The market would’ve liked to see faster synergies,” says VanCronkhite. Food price deflation was also a point of concern. The fund manager is taking a longer view, and expects TreeHouse to throw off $500 million-plus in free cash flow over the next five years from $213 million last year. Its valuation? “Wildly attractive in the consumer-staples space,” he says.
Harris. The communications equipment leader provides radio, satellite, and other advanced technology for various defense and commercial uses. Harris became of interest to VanCronkhite when CEO Bill Brown took the helm in 2011. “He had a history of making acquisitions,” he says. One of the first things Brown did was buy rival Exelis for $4.6 billion. The chief also cleaned house, divesting noncore businesses. VanCronkhite expects the company’s more-concentrated portfolio of assets to produce higher levels of cash flow over the next three to five years, generating some $1 billion in free cash flow in fiscal 2017, which ends in June, from $772 million this year. Another reason to be optimistic: Activist firm Jana Partners acquired two board seats in August, increasing the likelihood of even more value creation. At $89, its shares yield 2.4%.
Wendy’s. Last year, Barron’s said the burger chain’s stock was undervalued by 30%. At a recent $10, shares have gained about a dollar since then, keeping the door open for investors. “Everyone knows Wendy’s products, but I don’t think the market prices in the way the business is run,” says VanCronkhite. Its management team has been on a “multiyear, multipronged” program to raise shareholder value, and the company has almost completed its move to a 95% franchise-owned model. It has also remodeled stores, updated menu options, and invested in technology to roll out more-efficient localized pricing—all of which should drive same-store sales, he says.
DST Systems. The largest provider of transaction processing to the financial services industry has turned to the health-care industry for additional growth. “DST rejuvenated their business model under a wealth and health platform,” says VanCronkhite. Shares fell nearly 13% after the company reported third-quarter revenue of $387 million, below analyst expectations of $393 million. CEO Steve Hooley suggested that there was more pain to come, and said that regulatory changes, competition, and consolidation within health care and financial services would create challenges. “That’s short term,” says VanCronkhite. Over the long term, he expects DST’s investments in technology to pay off. Free cash flow came in about $109 million in 2015, and he expects that to more than double over the next five years. Shares, which recently traded at $97, yield 1.4%.
Arris International. The TV set-top-box maker’s customers are some of the biggest names in cable, such as Comcast (CMCSA) and Charter Communications (CHTR). And they’re incentivized to be good customers. “They have access to buy Arris stock at a specific price based on how much revenue they bring in,” says VanCronkhite. “Call it mutually assured success.” Arris is putting its cash to good use. Earlier this year they bought British media firm Pace for $2.1 billion, which opens up new satellite technology, a new customer base, and new markets. VanCronkhite expects the value of that deal to become apparent over the next two years. The biggest risk is the Federal Communications Commission’s plan to help TV viewers ditch set-top boxes. Those fears are figured into Arris’ stock price, at a recent $27, but VanCronkhite says they are overblown.