Although Nicklin is not constrained by company size, the concentrated portfolio of about 45 stocks is mostly in mid-cap territory. About 55% of the names have market capitalizations of $2 billion to $10 billion. Larger companies with public values of between $10 billion and $50 billion account for another 35% of the portfolio. The team has cast its net into widely diverse sectors, with business products and services taking the lead at 15.1% of assets, followed by industrial specialty products at 14.3% and oil and gas producers at 12.1%.
The fund shuns risk by steering clear of companies with chronic issues that can drive them to their knees in the long run, such as a portfolio of bad loans or a shrinking customer base that shows little promise of growing. Instead, the fund moves in when a company falls out of favor with Wall Street for what is likely to be a temporary problem. Nicklin buys names selling below what he considers intrinsic value, which he defines either as what a private buyer might pay or what he believes a company's value would be on the public market in a turnaround when everything else at the company is running smoothly.
It's not only disappointing earnings that cause a stock's price to hiccup. Sometimes a company is hit by a regulatory curveball. Other times, investors get shaken up about all the debt they see after an acquisition or a spin-off. But if a company can overcome those obstacles-by generating free cash flow, for instance, or by showing some other advantage steering it in the direction of long-term profitability-then Nicklin will consider buying. His interest is also aroused by changes in corporate management, by new products or by any other developments that suggest a good change in fortune at a company.
In a turnaround such as an acquisition or a stock buyback, Nicklin is willing to wait as long as two years to see how it pans out and will often hang on long after that if the premise for owning the stock still holds. His long-term outlook is one of the reasons that the portfolio turns over at about one-tenth the rate of the average stock fund. Once a stock reaches a predetermined price target or its fundamentals deteriorate or the premise for buying it no longer holds, Nicklin will likely sell it.
The portfolio's holdings include FMC Corporation, a diversified chemical company serving agricultural, industrial and consumer markets. Nicklin bought the stock soon after the company released a disappointing earnings report. A new holding, Beckman Coulter, makes instruments, chemicals and software for laboratories. This stock suffered a setback after problems were discovered with one of its lab tests. Nicklin believes the issue is neither huge nor lasting.
These stocks join the longtime fund holding Dr. Pepper Snapple Group. Nicklin first began buying the stock two years ago, after former parent company Cadbury Schweppes loaded the company down with debt as part of a spin-off. The stock languished for months as the Snapple brand lost its luster and sales lagged in the slowing economy.
Nicklin believed the company had a number of things going for it-a recognizable name and a loyal base of fans, including a number of friends who considered the taste truly unique. "The company improved distribution and was able to expand geographically and into fast food restaurants such as McDonalds," he says. "And it recast Snapple as an all-natural product by replacing corn syrup with sugar and changing its packaging." A $900 million windfall from Pepsi for the rights to distribute Snapple product was an unanticipated bonus.
One of the smaller companies in the portfolio is Baldor Electric. Nicklin first bought this stock three years ago when Baldor acquired a competitor, saddling itself with a large amount of debt in the process. But the deal paid off by opening up new markets to the company and by lowering its operational costs. With its ample free cash flow, Baldor has made significant progress in paring down its debt.
Nicklin's requirement that companies have a competitive advantage knocks out most commodity plays from his consideration, since recycling helps ensure an ample supply. An exception to this rule is oil stocks. "Oil is a different animal because it is so integral to growth in countries around the world. And you can't recycle oil. You have to keep finding it."
The fund bought a position several years ago in Anadarko Petroleum shortly after the company announced its acquisition of two major competitors for more than $23 billion. The deal left Anadarko deeply in debt, and when its stock fell, Nicklin moved in. Later, the driller's fortunes improved as its global exploration programs proved fruitful and its balance sheet improved as it sold off assets to pay down debt.