Global All Cap Strategy

June 2019

THE MARKET ENVIRONMENT
Major global markets finished mixed in the second quarter. The reporting period began steadily enough, but fears regarding new tariffs and trade wars caused market volatility mid-quarter before markets rallied in June. Trade talks between the U.S. and China faltered once again and rattled markets in May, despite some forward progress in April. However, following meetings at the G-20 Summit in late June, markets cheered the progression made by U.S. President Donald Trump and Chinese President Xi Jinping, both of whom agreed to reopen trade negotiations and cease additional tariff increases in the hopes of eventually reaching a trade deal. Similarly, after announcing a planned 5% tariff on goods imported from Mexico in May with the goal of deterring illegal immigration from Mexico into the U.S., Mexico’s efforts to mitigate this issue were enough to prompt Trump to suspend his plans to implement new tariffs on the country. Irrespective of the noise, indexes in the U.S. touched record highs during the period. 
 
Meanwhile, crude oil prices also experienced instability in the second quarter as markets weighed the implications of data and global happenings on supply and demand. In April, the U.S. announced it was ending sanction waivers on Iranian-produced crude oil, sending prices higher. However, continued uncertainty regarding trade tensions sparked demand concerns in May. Ultimately, growing tensions between the U.S. and Iran and subsequent supply uncertainties spurred a boost to crude oil prices late in the second quarter.  
 
In the U.K., Prime Minister Theresa May announced her resignation, effective June 7, as she was unable to build consensus on a Brexit deal to lead her country out of the European Union (EU). As of the end of the second quarter, May’s replacement had yet to be named. As things stand, the country will leave the EU on October 31 with or without a deal (unless a withdrawal agreement is settled upon prior to that date), leaving room for many possible outcomes and causing continued unease for investors.  
                                                                                                                                                                      
We believe that although a company’s share price may be performing poorly, it is not always indicative that a business is performing poorly. We seek to identify companies with hidden value that feature high-quality business fundamentals and management teams that act in the best interests of shareholders. Often these opportunities unearth themselves during ambiguous times like these when we can take advantage of short-term hindrances to unlock underlying value in underappreciated companies. 

THE PORTFOLIO
Top Performers:
TE Connectivity delivered a positive fiscal second-quarter earnings report that included revenue ($3.41 billion vs. $3.36 billion) and earnings per share ($1.42 vs. $1.27) that topped consensus estimates. The industrials business achieved 5% organic growth and the segment’s operating margin expanded 190 basis points to 15.8%, while the communications business realized 18% margins (+260 basis points) in the second quarter. In addition, management initiated a new $250 million reorganization plan for the transportation segment with the intent to consolidate some plants in high-cost countries and restructure the supply chain. In our view, TE Connectivity is nearing the end of a journey to becoming a collection of secularly advantaged connector businesses that can grow revenue in the mid-single digits with a high-teens operating margin and generate a return on invested capital of about 50%. We remain pleased with management’s execution and the company’s fundamental performance. 

Arconic’s first-quarter revenue of $3.54 billion met market expectations, while earnings per share of $0.39 exceeded market forecasts by about 10%. Revenue grew 3%, driven by volume growth across all business segments along with price increases in aero engines and fasteners with new contracts repriced at higher rates. Earnings (excluding one-time items) and earnings per share increased 15% and 26%, respectively, while margins expanded 120 basis points. Management also increased its guidance for full-year earnings per share and adjusted free cash flow. Following $700 million in share repurchases (about 7.5% of shares outstanding) in the first quarter, the company announced a plan to repurchase $200 million worth of additional shares at an accelerated pace. Notably, CEO John Plant and another director bought $1.1 million and $500,000 worth of stock, respectively, in the quarter. Even accounting for Arconic’s recent price increase, its shares are still trading at a healthy discount to our estimate of intrinsic value. 

Mastercard reported solid first-quarter results, in our assessment. Net revenue grew 13%, operating income rose 20% and earnings per share increased 24% year-over-year in constant currency. In addition, revenue exceeded market expectations by roughly 1% and earnings per share surpassed forecasts by slightly more than 7%. Results were driven by gross dollar volume and purchase volume that both advanced 12% (local currency) worldwide and cross-border volume climbed 6%. Operating expenses also fell 5% and were lower than market projections. Lastly, the company repurchased $1.8 billion worth of stock (about 8.7 million shares) in the first quarter and subsequently bought back an additional 2 million shares (worth $467 million), which leaves $4.5 billion remaining under the current repurchase authorization. We continue to see Mastercard as a compelling investment that should reward shareholders over the long term.

Bottom Performers:
Escalating investor concerns surrounding plans by some Democratic U.S. presidential candidates to implement a “Medicare for All” policy (which would create a new federally financed health care system) pressured share prices of managed care providers, including Tenet Healthcare. Some health care suppliers argued that such a plan would destabilize the country’s health system and have a severe impact on the economy and jobs, all without fundamentally improving access to health care. We contend that even if a candidate in favor of universal health care is elected, implementing this plan would require a large-scale and protracted legislative change. In the meantime, Tenet’s first-quarter results included total revenue, earnings and earnings per share that exceeded market forecasts. However, underlying results in the hospital segment were mixed as same-hospital net patient service revenues grew 1.9% and net revenue per adjusted admission rose 1.3%, while net operating revenue from hospital operations fell 2.2% and total admissions declined 0.1% from a year earlier. Even so, management’s guidance for the second-quarter and full-year periods were largely in line with analysts’ estimates. Late in the quarter, the company announced a new multi-year agreement with Aetna (a CVS Health company) to provide members with ongoing in-network access to all of Tenet's hospitals, emergency centers, outpatient centers and other services. We think that while Tenet may face some short-term obstacles, its long-term outlook remains promising. 

Ryanair Holdings reported fiscal full-year net income (excluding results from subsidiary Lauda) of EUR 1.02 billion, which was aligned with management’s prior guidance. However, net income fell 29% from a year earlier. Even though total revenue grew 6% and reached EUR 7.56 billion, it fell short of market forecasts. In addition, traffic (including Lauda) advanced 9%, though average airfare dropped 6%. Subsequently, several market analysts issued negative reports for Ryanair and downgraded the company. Management’s fiscal-year 2020 guidance includes traffic growth of 8% and an increase in passenger unit revenue of 3%. Management also stated that, thus far, current-year first-half bookings are slightly ahead of the same period last year, while fares are lower. Management expects this trend will continue through 2019. In the meantime, management issued a new EUR 700 million share buyback program scheduled for completion within the next 9 to 12 months. We still trust that Ryanair’s management team will continue to improve the airline’s competitive position while de-risking the model via high asset ownership and a strong balance sheet, which we believe should benefit long-term shareholders. 

Alphabet’s share price fell mainly in the middle of the quarter upon releasing first-quarter earnings. Results were sound, by our measure, given that total revenue grew 19% (constant currency) to $36.3 billion. While revenue growth decelerated somewhat compared to increases from prior first-quarter periods (e.g., +20%-23% growth in the first quarters of 2016 through 2018), we do not view the lower growth as being outside of the typical range. Furthermore, Google segment revenues advanced nearly 17% from last year (excluding effects from the $1.7 billion European Union fine) and Google paid clicks rose 39%. On a conference call subsequent to the quarterly release, CFO Ruth Porat expressed that some revenue variability is normal due to adjustments from “product innovations and enhancements” as well as comparisons with “strong 2018 results.” Overall, we believe investors overreacted to signs of slowing growth as Alphabet continues to meet our long-term expectations. Later, the company’s share price sank on news that the U.S. Department of Justice would conduct an antitrust investigation on Google. While we continue to monitor the situation, we believe the valuation for Alphabet remains attractive, offering a compelling reason to own.

During the quarter, we initiated a position in Samsung Electronics and eliminated USG from the portfolio.

Past performance is no guarantee of future results.

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