International Equity

December 2016

THE MARKET ENVIRONMENT
Major global market movements in the fourth quarter were largely influenced by the results of the U.S. presidential election in November. Although futures for the Dow Jones Industrial Average dropped nearly 900 points in the immediate aftermath of the election, investors surprisingly absorbed the implications of this political sea change. Subsequently, key indexes rebounded, and the Dow went on to close at a record high level on November 10 and finish up for the quarter. Financials led the advance, first benefiting from investors’ hopes that the new Republican administration would roll back industry regulations and second from the Federal Reserve’s decision to raise short-term interest rates for the first time in 2016. Citing signs that the economy has improved, the Fed also stated it intends to raise rates three times in 2017. 
 
Elsewhere, the European Central Bank and the Bank of England both maintained key interest rates in December. The Bank of Japan (BOJ) opted to maintain its yield-curve and asset-purchasing programs. In addition, the BOJ pledged to further expand the monetary base in its continued efforts to lift inflation above 2%. In the weeks following the U.S. election, the Japanese yen sank over 10% against the dollar, which some investors expect will boost Japanese exports.
 
Meanwhile, members of the Organization of the Petroleum Exporting Countries (OPEC) reached an agreement with non-members to further reduce oil production. As a result of the deal, an additional 600,000 barrels per day will be removed from the market in addition to the 1.2 million barrel per day cut agreed upon by OPEC in November. When all was said and done, Brent crude finished up approximately 52% for the year.
 
As value investors, we feel that our key task is to see through the haze generated by market pundits who are overly influenced by geopolitical events such as referendums and elections. Instead, we focus on the fundamental drivers of long-term cash flows. We seek to make investment decisions based on a company’s ability to generate and sustain a growing cash flow stream. While the market chased stable stocks in the face of uncertainty, we felt the attractive valuations in financials and cyclically-exposed areas of the market provided more safety. As is often the case, share price declines from the macro events of 2016 afforded us the opportunity to act on our convictions and reward our patient shareholders. 

THE PORTFOLIO
Top Performers:
Glencore’s share price reacted positively to a rebound in commodity prices, the successful execution of its debt reduction plan and the election of Donald Trump as U.S. President. During the quarter, Glencore completed its sale of non-core assets and raised a total of $6.3 billion in proceeds from all asset disposals, which puts the company on pace to meet its targeted net debt level of $16.5-$17.5 billion. Furthermore, management reinstated its dividend policy and plans to return at least $1 billion to shareholders starting in 2017. We believe management is working to enhance shareholder value, and our investment thesis remains intact.

We appreciated the results from BNP Paribas’ fiscal third quarter, which showed that net income (EUR 1.89 billion vs. EUR 1.64 billion), revenue (EUR 10.59 billion vs. EUR 10.24 billion) and operating income (EUR 2.61 billion vs. EUR 2.47 billion) bested consensus estimates. In our view, BNP demonstrated a strong top line and lower credit costs during the reporting period to more than offset slightly higher operating expenditures. Later in the quarter, the European Central Bank’s 2016 Supervisory Review and Evaluation Process showed that BNP Paribas’ capital ratios were well above regulators’ required minimums for 2017. Furthermore, it was reported that the company would reorganize its retail banking network in France by replacing the three-level system at present with a two-level system in 2018. The report suggested that the new system could result in significant savings for BNP Paribas. We think management has a solid plan for the future and the investment will continue to provide value for our shareholders.

CNH Industrial’s share price was boosted in the fourth quarter by the election of Donald Trump and the perceived benefits to the industrials sector. In addition, news that industry peer Deere delivered fiscal fourth-quarter earnings results that handily beat market expectations drove CNH’s share price higher during the reporting period, on hopes that the latter would follow suit. As previously mentioned, non-members of the Organization of the Petroleum Exporting Countries (OPEC) reached an agreement with OPEC members to further reduce oil production. As a result of the deal, an additional 600,000 barrels per day will be removed from the market in addition to the 1.2 million barrel per day cut agreed upon by OPEC earlier in the quarter. In conjunction with the recovery in oil prices during the quarter, we find that the company continues to be undervalued relative to its normalized earnings power. 

Bottom Performers:
The U.S. presidential election results prompted an immediate drop in the value of the peso and negatively impacted Grupo Televisa’s share price. We expect advertising budgets will be under pressure in 2017 given the uncertain environment caused by the U.S. election, as advertisers take a more conservative and cautious approach going forward. While we expect near-term volatility to continue, we believe Televisa’s fundamentals remain strong. Third-quarter results were in line with our expectations and company guidance. The Cable and Sky segments performed well, growing 12% and 13%, respectively. We believe the company possesses a collection of great assets that the market continues to undervalue, and our investment thesis remains intact.

Even though Baidu’s full fiscal nine-month results were largely in line with our forecasts and its third-quarter earnings per share exceeded market expectations, total quarterly revenues fell somewhat short. Despite a third-quarter sales decline of 1% in the core search business, total sales for the full fiscal nine months grew 10% from a year ago. We like that spending related to its online-to-offline business venture dropped for the period, which resulted in a 23% year-over-year decrease in overall operating expenses. In addition, an unconfirmed report that Baidu is planning to spin off its video subsidiary iQiyi.com (which it had previously attempted to sell to Robin Li, Baidu’s Chairman) seemed to please investors. Furthermore, the company made progress complying with new advertising regulations in China. Accordingly, management expressed confidence that the business would return to growth early in 2017.

Bureau Veritas’ fiscal third-quarter earnings report showed that revenues were in line with analysts’ outlook. However, management lowered its full fiscal-year guidance with expectations for slightly negative organic revenue growth driven by negative growth in the Marine segment and Oil & Gas expenditure weakness. After speaking with the company’s CEO, we find that management’s attempts to invigorate sales growth are trailing expectations and are being hampered by exogenous headwinds. That being said, we continue to believe the valuation for this high-quality business remains attractive, offering a compelling reason to own.

During the quarter we initiated positions in BMW, Infosys ADR and Sanofi

Past performance is no guarantee of future results.

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