The Gannon Report

At The Royce Funds, our work requires that we spend substantial time with corporate management teams, both those from companies that currently populate our portfolios and those who run businesses that are potential candidates. These conversations provide us with unique perspectives and insights into industries and sectors that go beyond a company’s metrics and into other interesting areas.

Over the past year, economic growth has slowed dramatically, the Federal Reserve has become increasingly accommodative, and inflation has taken center stage as the central economic anxiety. The de-leveraging process has pressured the equity markets, frozen the credit markets, and increased volatility nearly everywhere. To be sure, the overall economy is weak, which explains why so many of our recent conversations with the executives of many consumer-related businesses have been focused on the over-burdened, indebted consumer. We have also heard from executives in other industries, such as small chemical companies that manufacture vinyls and polymers, who tell us that their housing-related businesses continue to struggle, making cost control their paramount concern.

Inflation is also having a very real effect on the profits of many companies. Several management teams we have met with have noted the rapid rise in commodity costs, from steel to rubber. One manufacturer of filtration products recently noted that steel costs have risen some 50% year over year, with the majority of that rise taking place in the first half of 2008. Another executive mentioned to us recently that higher steel prices are causing a greater deceleration in new non-residential construction than credit availability issues. Countering this somewhat is the genuine industrial recovery in the United States, which stems both from market-share gains due to the weak dollar and emerging-market demand for our products. Several industrial companies whose shares we own have noted ongoing strength in their business as well as robust demand. For these businesses, current economic conditions are quite dynamic.  

Outside of industry-specific trends, we hear interesting stories about access to capital. The cost of taking a company public in the United States, for example, is now more expensive than ever, which has financial implications for smaller companies searching for capital. Recently, a small, very profitable Texas-based company in the energy business went public on the Toronto Stock Exchange rather than opt for New York’s. Management discussed just how onerous and expensive the process is to go public in the U.S.

Some 30-plus years ago when we started running Royce Pennsylvania Mutual Fund, those who obtained information first had a real advantage.  Since information is now distributed to nearly everyone simultaneously, the advantage rests with those who are able to better process and evaluate it. We believe that our New York City location affords us a substantial competitive advantage because we have significant access to management teams. We average five to eight meetings per day in our office, in addition to attending the many conferences that take place in New York throughout the year. These meetings are generally conducted using the Socratic method, in which we pose numerous questions in an attempt to arrive at an accurate picture of a company. After all, what we seek are good long-term investment partners.

Stay tuned…
FDG