October 23, 2012

Dear Fellow Shareholders:

The Bretton Fund’s net asset value per share (NAV) as of September 30, 2012, was $19.85, and the total return for the fund for the quarter was 3.44%. Over the same period of time, the total return for the S&P 500 Index was 6.35%, and the total return for the Wilshire 5000 Total Market Index was 6.15%.

Total Returns as of September 30, 2012

3rd Quarter1 YearAnnualized Since
9/30/10 Inception
Bretton Fund3.44%36.06%15.68%
S&P 500 Index6.35%30.20%14.74%
Wilshire 5000 Total Market Index6.15%29.89%14.28%

Performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. Current performance may be lower or higher than the performance data quoted. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. You may obtain performance data current to the most recent month-end here or by calling 800.231.2901. The fund’s expense ratio is 1.50%.

Contributors to Performance
The largest impact on the fund was Gap, which added 2.7% to the fund’s performance as its share price increased 31% during the quarter. Other positive contributors were Aflac, adding 0.9%, and JP Morgan Chase, whose stock price has rebounded a bit since its trading losses last quarter, adding 0.7%.

The largest negative impact to the fund was the railroads CSX and Norfolk Southern, which together dragged the fund’s NAV down by 1%. These East Coast railroads derive much of their revenue from transporting coal, and a confluence of events (power plants switching to low-priced natural gas, regulatory changes, a warm winter, slowing steel production overseas) led to a sharper drop in the amount of coal moved than investors were expecting, myself included. While the amount of coal they ship might bounce back with a rise in natural gas prices or a cold winter, coal will eventually become a less important part of their business. Over time, I believe their defensible economics and other areas of their business, notably their increasing ability to handle traffic traditionally moved by trucks, will more than make up for lower coal revenue.

Apparel Addendum
In last year’s shareholder report for June 30, 2011, I described how abnormally high cotton prices were hurting the earnings of Carter’s and Gap and how that presented an opportunity for Bretton Fund shareholders, given the fund’s longer-than-average time horizon and that extreme cotton prices was almost certainly temporary. Referring to Carter’s, I wrote, “This investment is in the sweet spot for the Bretton Fund: a great business facing a temporary problem.”

Since reaching a 140-year high of $2.40/pound, cotton prices have come down to around $0.70/pound, right in line with average prices over the past few decades. In their most recent fiscal quarters, Carter’s earned 61% more per share than it did last year and Gap earned 43% more. Since June 30, 2011, their share prices are up 77% and 103%, respectively. The fund has since sold some of its holdings in both companies.


Security% of Net Assets
Ross Stores, Inc.10.5%
Aflac, Inc.7.7%
CSX Corp.6.9%
Wells Fargo & Company5.5%
The Gap, Inc.5.3%
JP Morgan Chase & Co.5.3%
American Express Co.4.6%
Carter’s, Inc.4.4%
Norfolk Southern Corp.4.1%
America's Car-Mart, Inc.3.9%
Union Pacific Corp.3.5%
CapitalSource, Inc.3.4%
New Resource Bank3.1%
Standard Financial Corp.2.5%
SI Financial Group, Inc.2.2%
Apollo Group, Inc.1.8%

*Cash represents cash equivalents less liabilities in excess of other assets.

The fund sold off its investment in Peoples Federal Bancshares during the quarter. Like SI Financial and Standard Financial, two banks the fund continues to own, Peoples Federal is a small, conservatively run bank that recently converted to a traditional stock corporation from a mutualized thrift structure, a structure in which the depositors technically own the bank. The conversion process essentially left the bank with excess cash and its stock trading below book value, which is when the fund purchased its shares. As the stock price has accreted toward its book value, the fund sold off its position. The total gain to the fund was 25% (16% on an annualized basis), a decent return given a modest degree of risk.

America’s Car-Mart
With the market up 30% the past year, it’s become much more challenging to find investments that have a compelling rate of return and only a small chance of incurring a loss. After sifting through a few thousand businesses, the fund made its first new investment in nearly a year with the addition of America’s Car-Mart. Car-Mart bears a similar name to a much larger company that’s also headquartered in Bentonville, Arkansas, as well as a similar strategy: selling low-priced goods to low-income consumers. In Car-Mart’s case, it’s used cars. A significant number of Americans who are struggling financially are unable to get a loan to purchase a car, much less have enough cash to pay for a car upfront. Most used-car dealerships are small and independently owned, and they arrange third-party loans for their customers from a bank. But banks are often reluctant to make loans to customers with bad credit, especially if they don’t have direct relationships with them. Car-Mart fills a need by both selling cars and providing financing.

The used cars it sells aren’t exactly ’70’s Pontiac Trans Ams (with t-tops). Think more along the lines of an eight-year-old Ford Taurus with 100,000 miles on it. These cars are utilitarian, filling a functional need for its customers who otherwise wouldn’t be able to have a car. Not surprising, Car-Mart’s default rates are high, and it factors this into the selling price of its cars. The company only locates in towns with populations less than 50,000 because it believes it can better manage its default rate by knowing its customers and operating as part of the community. Car-Mart operates in a customer-centric way in what often is a seedy market. Most customers make their bi-weekly payments in person at the dealership, and Car-Mart offers free check-cashing for those who want to pay directly from their paychecks. When customers can’t afford their payments, often the result of losing jobs, most return their cars directly to the dealership or have them picked up voluntarily. By selling low-cost cars in a fair way to customers who have been shunned by other dealerships and banks, Car-Mart has fostered a highly loyal customer base. Repeat business is 30% of sales, 50% at some of its older dealerships, and it estimates referrals are another 10–15% of its business. Car-Mart’s been doing this since 1981 and has done well throughout a lot of ups and downs in the economy. Its knowledge of this business and its reputation are hard to replicate, and despite its success, it’s the only company in this industry at a meaningful scale.

Car-Mart operates 117 dealerships in nine states, primarily in the South. It could double its number of locations without having to expand outside of its current geography, and there are a lot of places in the US that would benefit from a Car-Mart. In other words, the company has a very long runway to build its business. It plans to increase the number of dealerships by 10% a year, which would double its size seven years from now. I anticipate Car-Mart will operate hundreds and hundreds of dealerships in the years to come. It’s been able to fund its growth using the cash flows from its existing dealerships, instead of having to issue more equity or take on excessive debt. Additionally, Car-Mart is one of those rare businesses that can expand rapidly without a lot of additional capital and whose management is both willing and able to use its excess cash to buy back its own shares. In just the past two and a half years, the company has repurchased 25% of its outstanding shares, increasing the amount remaining shareholders own of the company by a third. As the company continues to expand while buying back its own stock, shareholders will own an increasingly larger pro rata ownership of many more dealerships. As with any company that buys back its own stock, the lower the share price, the more of the company it can buy back, so let’s hope for a low share price for years to come.

Bretton in the News
In August, Reuters published a profile of me and the Bretton Fund. Reporter David K. Randall wrote:

When looking at stocks, he’s trying to identify companies that have “defensible” business models that are trading at a discount to what he thinks the business is worth, he said. For example, he has a stake in each of the three major railroads—CSX, Union Pacific, and Norfolk Southern—because it’s a play on economic growth with a high barrier to entry.

“If you and I wanted to create a trucking company, we could go out tomorrow and be up and running. But if someone gave us a billion dollars to create a railroad company, we couldn’t do it,” he said.

(A side note: Randall, the reporter, recently published a fascinating book on the science of sleep called Dreamland, which has been prominently excerpted in the The New York Times and The Wall Street Journal, at one point ranking as NYT’s most-emailed story. I recommend it; I assure the reader no biblio quid pro quo has been made.)

A recent Bloomberg article by Lewis Braham mentioned the fund in an article about looking for profit in “scandal stocks.”

“One of the best ways to make money is to have the ability to look past a bad headline,” says Stephen Dodson, manager of the Bretton Fund. “If you have the time horizon to be able to do that, it’s one of the greatest advantages you can have.”

I rest comfortably knowing Bretton Fund shareholders are already well aware of this advantage.

Thank You
As the fund reaches it second birthday and steadily grows in assets, I want to thank the fund’s shareholders for being the early investors in the fund and, more important, for their long-term orientation, an increasingly rare trait among investors today.

Thank you,

Stephen J. Dodson
Bretton Capital Management