International Equity

June 2017

A little over one year ago, citizens of the U.K. voted to leave the European Union. Global equity markets strongly reacted to this decision as the pound sterling dropped and the yen, viewed as a “safe haven,” strengthened. In addition, stocks dropped globally, especially in the European Union and the U.K. As the yen strengthened, share prices of Japanese stocks softened, especially of exporters, and European financials were particularly hard hit.
Despite the uncertainty caused by Brexit and a recent general election in the U.K., which resulted in a lost majority for the still-governing Conservative Party, the British economy is performing acceptably well with a 2% year-over-year growth rate. To be sure, economic challenges remain, but the weaker pound sterling has aided currency-sensitive sectors such as exporters and tourism. Meanwhile, strong employment has indicated that the recession many predicted has not materialized. Furthermore, economic sentiment in the eurozone reached its highest level in June in nearly a decade.
Similarly, the U.S. economy is still showing signs of strengthening as the unemployment rate fell in May to a 16-year low of 4.3%. Consumers in the country are enjoying low price inflation and seasonal gasoline prices that have reached the lowest levels since 2005. Correspondingly, the Federal Reserve expressed confidence that the economy is on solid ground and, as widely anticipated, raised its key interest rate by one quarter point in June. 
Though events like Brexit are often traumatic and very difficult to stomach, they can provide opportunity for those who are patient. We used Brexit to actively increase our exposure to select companies that realized a wider discount to intrinsic value. No matter the geopolitical landscape, we continually search for and invest with companies that are committed to putting shareholders first and are trading at large discounts to our perception of their true worth. This discipline is deeply embedded in our philosophy and process.

Top Performers:
Intesa Sanpaolo reported good first-quarter results that were in line with our expectations. In our view, costs remain well controlled and asset quality continues to improve as non-performing loans decline. Intesa’s share price also reacted favorably when the European Central Bank and the Italian government announced plans to rescue two Italian banks, putting an end to months of concern that failures of these banks could undermine confidence in the Italian banking system. As part of the deal, Intesa will acquire EUR 26 billion of performing loans and EUR 4 billion of high-risk performing loans from the two banks. The asset quality of the performing loans is higher than the average of Intesa’s current portfolio, and the company will have the option to return the high-risk performing loans to the government if asset quality deteriorates. Although management had not been interested in acquisitions previously, we believe the assets and terms of this transaction are attractive and provide good potential to create value for shareholders. CNH Industrial delivered positive first-quarter earnings with both revenue and earnings that exceeded market estimates. Performance in the industrial business improved, as earnings increased 34% year-over-year, driven by a 77% improvement in the Agriculture Equipment segment. The industry has seen stabilization in global agricultural equipment markets and is beginning to see the early stages of restocking. In addition, Standard & Poor’s upgraded CNH Industrial’s long-term corporate credit rating, which indicates an improved outlook for the company. The upgrade should allow CNH to improve its balance sheet efficiency and refinance debt at lower rates. Lastly, the company announced it is renewing its share buyback program and will repurchase up to $300 million worth of stock with a planned end date in October 2018. We are confident that CNH Industrial’s fundamental performance will continue to strengthen. BNP Paribas reported solid first-quarter results, by our measure. Revenues rose 7% from a year earlier driven by unexpected French retail loan growth and expectedly strong business in the Corporate and Institutional Banking unit. Net income reached EUR 1.89 billion and surpassed market estimates by 30%. In addition, we think the election of France’s President Emmanuel Macron is a favorable development for BNP, as Macron appears to be pro-business and wants to maintain and even deepen ties with the European Union (EU). Macron has also called for undertaking structural reforms in areas such as labor, corporate tax rates and regulation. In our view, a lower risk of a French exit from the EU and faster economic growth will serve as positives for BNP Paribas and provide an increase to the upside potential of the company. 

Bottom Performers:
We have been a long-term shareholder of Honda Motor, but we have grown increasingly frustrated with management’s inability to explain continued margin weakness in its auto segment. Despite entering the “sweet spot” of the model cycle, margins continue to be weak. In addition, management has made multiple missteps at a time when the company’s main market, North America, has been booming. While Honda is still trading at a discount to its intrinsic value, we have lost faith in management’s ability to create long-term shareholder value. Therefore, we decided to sell our position in Honda. Glencore’s first-quarter production report was broadly in line with our expectations, but lower than market expectations for copper, zinc, coal and oil, pressured the company’s share price. Zinc production increased 9% and coal production grew 4% from the same quarter last year, while copper production decreased 3% owing to factors that traditionally make the first quarter seasonally weak. Oil output also declined 43% from a year earlier, which reflected the expected ongoing depletion of oil fields. Even though output may fluctuate in the near term, management’s full-year production guidance across all commodities remained unchanged. Furthermore, Glencore announced it sold 51% of its petroleum products storage and logistics business to Chinese conglomerate HNA Innovation Finance Group, culminating in the formation of a new company, HN Storage International. This transaction paves the way for additional returns to shareholders, as Glencore continues to reduce debt in keeping with its current strategic objectives. As Grupo Televisa forewarned, its first-quarter results were weak. Both sales and earnings growth fell short of market forecasts as well as our estimates, as each increased only 2% year-over-year. Content unit sales declined 3% from a year earlier, driven by a drop of 8% in the core Advertising business, as sluggish demand in the banking, telecom and soda/snacks sectors pressured sales. Conversely, sales in the Cable and Sky units advanced 6% and 4%, respectively. Overall, we were pleased with margin growth in the Content and Cable units, which was spurred by effective cost control. Margins contracted somewhat in the Sky unit, but were largely in line with our estimates. We met with Grupo Televisa’s management team later in the reporting period and came away impressed with the company’s newly appointed head of content, Isaac Lee. Lee has brought new discipline to the group where content is now selected based on surveys and research. In Mexico, not only have the ratings increased as a result of this change, overall viewers have grown to prior peak levels as the company’s flagship FTA Channel 2 is gaining share from the cable networks. In our estimation, management has taken steps to improve the business in other segments as well, and Grupo Televisa is starting to see early signs of success. We think stronger underlying fundamentals should unearth themselves later in the year and into 2018.  

During the quarter we initiated a position in Axis Bank. We eliminated Check Point Software Technologies and Honda Motor from the portfolio.

Past performance is no guarantee of future results.

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Past performance is no guarantee of future results.

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